Accounting Concepts and Principles PDF

What is accounting? Accounting is the process of identifying, measuring and communicating economic information to allowed informed decisions and judgements by users of that information. It involves the following process: - - - All business organizations observe the general bookkeeping rul...

What is accounting? Accounting is the process of identifying, measuring and communicating economic information to allowed informed decisions and judgements by users of that information. It involves the following process: - - - All business organizations observe the general bookkeeping rules and principles. The difference between the accounts of these business units lies in the accounting for the owner's capital and distribution of profits. Users of accounting information Internal users are individuals or groups within a company who uses financial information for decision making and operational planning. Examples of internal users are: Management- use financial information for decision making and planning Employees- use financial statements for assessing job security and negotiating wages Owners- monitor the financial health and performance of the company External users' ae individuals outside the company who rely on financial information to make decisions Examples of external users are: Investors- evaluate the company's financial performance for investment purposes Customers and suppliers evaluate the company's ability to fulfil orders and stability Competitors analyse financial information for strategic planning Ethical principles in accounting Ethics is described as morals governing human behaviour. Professional ethics is known as the code of behaviour considered correct for a specific group or profession. Ethics are influence by certain factors such as: - - - - Fundamental principles of ethical behaviour from the International Ethics Standards Board for Accountants (IESBA) Code of Ethics. Five fundamental principles of ethical behaviour accountants are required to adhere to are: 1. 2. 3. 4. 5. Application of ethical principles: - - - - - - - - Unacceptable behaviour or inappropriate applications of ethical principles: - - - - - - - When working in a financial environment, employees should comply with the following principles: - - - - - - - - - Unfortunately, not all employees comply and work within the above accounting principles and some may resort to unacceptable behaviour such as: - - - - - - Due to inappropriate conduct, there can be consequences resulting from this such as: - - - - - - Technology and accounting Nowadays accounting records are usually produced using electronic systems and specialized accounting software packages. A wide variety of these are available, including Sage, QuickBooks and Microsoft Dynamics. main features: Automatic processing The computer operator extracts Information from source documents and inputs the relevant data into the software program. The other accounting processes are automatic: ledger accounts are updated Instantly, and trial balances and other financial statements can be produced on demand. Integration of functions As well as the main financial records, most software packages will also produce inventory records, generate documents such as invoices and credit notes and. In some cases, they produce payroll records. Management information Managers can often be provided with additional information to help run the business. such as details of amounts due from credit customers, analyzed according to the age of the debt, i.e. the length of time it has been outstanding. Advantages and disadvantages of computerization The benefits and potential drawbacks of computerized accounting processes are summarized below: Benefits Potential drawbacks. Greater accuracy due to automation of Capital expenditure: There could be a heavy initial outlay on processes Computer equipment and software programs; there is also likely 10 be the need to update at frequent Intervals. Greater speed because updating and Training costs: Staff will need support in using new equipment calculations are carried out virtually and software programs. and skills will need updating from time Instantaneously to time. Easier access to information using Risk of data loss: Systems can \'crash\', arid security of data can computer software to find particular details be a serious issue. More information available to help with Maintenance and support costs: Businesses have to invest in management and decision making technical support to ensure systems provide continual service. Reduction in staffing costs may be Period of transition: It is sensible to ruri old (manual) systems possible because record keeping Is mainly alongside new computerized systems at least for a time to ensure automatic that everything works as it should. Additional functions Computerized accounting systems can Include some useful additional functions, such as: Inventory control Inventor\'/ records can be automatically updated every time there Is a purchase of goods, a sale of goods, returns of goods. etc. Credit control Computerized records of accounts receivable can show how much is owed by each customer and for how long any debt has been outstanding. This can help raise awareness of late payers. Similarly, computerized records can be used to provide details of amounts owed to credit suppliers, making it easier to ensure that valuable cash discounts are not missed. Payroll Computer software programs can produce all the necessary detailed information about wage and salary calculations, pays lips, payroll registers, etc. Management reports Soft1Jo1are programs can automatically provide trial balances, income statements, statements of financial position (balance sheets), ratio analysis and audit trails. Accounting concepts and conventions A concept or convention is an assumption which is generally accepted or taken for granted without proof. In recording and reporting business transaction, we have to adhere to certain fundamental concepts. These concepts have been developed overtime to provide a general guide to prepare financial reports as objectively as possible. Some accounting concepts/conventions are: 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. Accounting cycle The accounting cycle traces the various steps in which business transactions go through before they are finally analyzing and presented as useful information reflecting the financial situation of the business. The various steps of the accounting cycle are as follows: 1. 2. 3. 4. 5. 6. Main financial statements 1. 2. 3. Accounting equation The bases of recording any transactions in accounting is the ACCOUNTING EQUATION. This equation shows the relationship between ASSETS, LIABILITES AND OWNER'S EQUITY ASSETS Assets are things of valued owned by a business because they bring benefits to the entity as a whole. They are acquired to assist in the day-to-day activities of the business. Assets can be classified into fixed and current assets. Fixed assets are acquired to help in the running of a business. They are not acquired for sales to customers. Fixed assets are permanent in nature and can be used for more than one accounting year Current assets are assets that can be easily converted into cash. Unlike fixed assets which are permanent in nature, the value of current asset changes. Example of fixed assets Land Building (premises) Machinery Motor vehicles Office equipment Office furniture Fixtures and fittings Examples of Current assets Stock (inventory) Debtors (people who owe the business) Prepaid expenses (expense that is paid in advance) Cash at bank Cash in hand LIABILITES Liabilities are those amounts owed by the business to outside parties. They can be classified into long term and current liabilities Long term liabilities are the amount owed which the business has more than one accounting year to settle. Current liabilities are the amount owed by the business that must be settle within one accounting year. Examples of long-term liabilities Bank loans Mortgages Debentures Examples of current liabilities Creditors (money owed by a business to its vendors) Accrued expenses (expenses incurred but not yet paid) Bank overdraft (not enough money in bank to cover transactions but the bank still allows it) OWNER'S EQUITY Owner's equity or capital is the investment made by the owner. It represents the owner's interest in the business. An owner can invest money or any assets into the business. *Any additional investments by the owner will increase owner's equity or capita.* The business entity convention tells us that the business is separate from the owner. Therefore, if the owner withdraws any assets for personal use, owner's equity will be reduced. Assets withdrawn for personal use is referred to as DRAWINGS. The accounting equation defines the relationship between assets, liabilities and owner's equity as follows: - - - 1. \$ ------------------ -------- Cash in hand 3,000 Debtors 6,800 Creditors 7,000 Bank overdraft 4,575 Stock 24,000 Motor vehicles 30,000 Office furniture 10,000 Mortgage 35,000 Loan from bank 15,000 Premises 45,000 Q1. Complete the table below: \# Assets\$ Liabilities\$ Capital\$ ---- ---------- --------------- ----------- 1 30,000 10,000 2 80,000 35,000 3 18,000 60,000 4 55,000 16,000 5 30,000 70,000 6 90,000 34,550 Q2. Distinguish between the following items that are assets or liabilities. a. b. c. d. e. Balance sheet Mr. X Balance sheet (simple) As at................... +-----------------+-----------------+-----------------+-----------------+ | Details | \$ | \$ | \$ | +=================+=================+=================+=================+ | **FIXED | | | | | ASSETS** | | | | +-----------------+-----------------+-----------------+-----------------+ | Land | | 100 | | +-----------------+-----------------+-----------------+-----------------+ | Building | | 200 | | | (premises) | | | | +-----------------+-----------------+-----------------+-----------------+ | Machinery | | 300 | | +-----------------+-----------------+-----------------+-----------------+ | Motor vehicles | | 400 | | +-----------------+-----------------+-----------------+-----------------+ | Office | | 500 | | | equipment | | | | +-----------------+-----------------+-----------------+-----------------+ | Office | | 600 | | | furniture | | | | +-----------------+-----------------+-----------------+-----------------+ | Fixtures and | | {.underlin | | | fittings | | e} | | +-----------------+-----------------+-----------------+-----------------+ | **TOTAL FIXED | | | 2 800 | | ASSETS** | | | | +-----------------+-----------------+-----------------+-----------------+ | **CURRENT | | | | | ASSETS** | | | | +-----------------+-----------------+-----------------+-----------------+ | Stock | 100 | | | +-----------------+-----------------+-----------------+-----------------+ | Debtors | 200 | | | +-----------------+-----------------+-----------------+-----------------+ | Prepaid | 300 | | | | expenses | | | | +-----------------+-----------------+-----------------+-----------------+ | Cash at bank | 400 | | | +-----------------+-----------------+-----------------+-----------------+ | Cash in hand | {.underlin | | | | | e} | | | +-----------------+-----------------+-----------------+-----------------+ | **TOTAL CURRENT | | 1 500 | | | ASSETS** | | | | +-----------------+-----------------+-----------------+-----------------+ | **LESS: CURRENT | | | | | LIABILITES** | | | | +-----------------+-----------------+-----------------+-----------------+ | Creditors | 100 | | | +-----------------+-----------------+-----------------+-----------------+ | Accrued | 200 | | | | expenses | | | | +-----------------+-----------------+-----------------+-----------------+ | Bank overdraft | 300 | | | +-----------------+-----------------+-----------------+-----------------+ | **TOTAL CURRENT | | [(600)]{.underl | | | LIABILITIES** | | ine} | | +-----------------+-----------------+-----------------+-----------------+ | **WORKING | | | {.underlin | | CAPITAL** | | | e} | +-----------------+-----------------+-----------------+-----------------+ | **NET ASSETS** | | | **[3700 | | | | | A]* | | | | | * | +-----------------+-----------------+-----------------+-----------------+ | **FINANCED | | | | | BY:** | | | | | | | | | | **OWNER'S | | | | | nEQUITY** | | | | +-----------------+-----------------+-----------------+-----------------+ | Capital | | 3000 | | +-----------------+-----------------+-----------------+-----------------+ | **Closing | | | 3000 | | capital** | | | | +-----------------+-----------------+-----------------+-----------------+ | **LONG TERM | | | | | LIBAILITIES** | | | | +-----------------+-----------------+-----------------+-----------------+ | Bank loans | | 400 | | +-----------------+-----------------+-----------------+-----------------+ | Mortgages | | {.underlin | | | | | e} | | +-----------------+-----------------+-----------------+-----------------+ | **TOTAL LONG | | | {.underlin | | TERM | | | e} | | LIABILITIES** | | | | +-----------------+-----------------+-----------------+-----------------+ | | | | **[3700 | | | | | B]* | | | | | * | +-----------------+-----------------+-----------------+-----------------+ EFFECTS OF TRANSACTIONS ON THE ACCOUNTING EQUATION All business transactions which take place will always affect at least two items in the accounting equation. This is based on the DOUBLE ENTRY SYSTEM OF ACCOUNTING. This system tells us that for every increase in one component of the accounting equation, there is a corresponding decrease in another component. This means that the quality of the accounting equation is always maintained. Transactions can be divided into two categories: Cash transactions: that involve the immediate use of money affecting either cash in hand or cash at bank. Credit transactions: where the payment or receipt of money Is delayed until a later date affecting the amount owed to suppliers (accounts payable) or owed by customers {accounts receivable). Transaction One of the effects is: the other effect is: ------------------------------------------------ ------------------------ ---------------------------- Purchased equipment and paid by cheque Equipment increased Cash at bank decrease Purchase a vehicle on credit Vehicle increase Accounts payable increase The owner invested more cash in business Cash increase Capital increase Sold unwanted furniture for cash Cash increases Furniture decrease Paid a credit supplier an amount due by cheque Cash at bank decreases Accounts payable decreases The owner withdrew a cheque for private use Cash at bank decrease Capital decrease Every time a transaction occurs it is possible to work out its effect on the statement of the financial position (balance sheet) of a business. This process is the simplest way of recording transactions. It Is Important to realise: each transaction affects two statement of financial position (balance sheet) items After the effect of the transaction has been recorded the accounting equation should still hold true, i.e. total assets equal total liabilities and capital. Guidance on recording transactions using the statement of financial position (balance sheet) For each transaction, Identify the two items that will be affected For each Item, decide whether its value will increase or decrease when the transaction occurs.