Lecture Notes On Accounting PDF

LECTURE NOTE ONE ================ Study Session 1: Nature and Purpose of Accounting ================================================= Introduction ------------ **Accounting is a service activity**. Its **function is to provide quantitative information, primarily financial in nature, about economi...

LECTURE NOTE ONE ================ Study Session 1: Nature and Purpose of Accounting ================================================= Introduction ------------ **Accounting is a service activity**. Its **function is to provide quantitative information, primarily financial in nature, about economic entities that is intended to be useful in making economic decisions, in making reasoned choices among alternative courses of action**. In this study session, you will be introduced to the **meaning of accounting, the difference between book-keeping and accounting, the purpose of accounting, the users and uses of accounting information.** Learning Outcomes for Study Session 1 ------------------------------------- On completion of this study session, you should be able to: 1. **Explain the Meaning of Accounting** 2. **Differentiate between Book-keeping and Accounting** 3. **Describe the Purpose of Accounting** 4. **Identify the Users and uses of accounting information** 1.1 Meaning and Definition of Accounting ---------------------------------------- Accounting is concerned with the recording, classifying, summarizing and communicating the financial information of an entity to interested parties and interpreting in order to aid business decisions. Businesses use accounting to keep their financial information organized which helps them in making sense of their financial data and also keeps them compliant of financial regulations. Although, accounting has often been viewed as an important tool of business, today every organization uses accounting in order to organize and make meaning of their financial data and better manage such entities. For this reason the use of accounting transcends businesses, governmental institutions, universities, societies etc. ### Meaning and Definition of Accounting Accounting has been described by many as the "language of business". Accounting provides the mechanisms for the identification, measurement and recording of economic information of an entity. **Box 1.1: Definition of Accounting** Accounting can be defined as the science of recording, classifying, summarizing transactions, reporting and analyzing financial data of an entity's result of operations during a particular period, and the financial position as the end of the period to the users of the financial statements for decision making**.** **(Personal construction**) Accounting is the process of recording the financial transactions of a business. The accounting process includes summarizing, analyzing, and reporting these transactions to oversight agencies, regulators, and tax collection entities and other users of accounting information. The financial statements used in accounting are a concise summary of financial transactions over an accounting period, summarizing a company\'s operations, financial position, and [cash flows](https://www.investopedia.com/terms/c/cashflow.asp). 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.  **The definition of accounting states that it includes recording, summarizing, reporting and analyzing financial data**. Let's try and explain the key terms involved in the definition to enable use understand the task and activities involved in accounting better and what it really means: *Recording* - The primary function of accounting is to make records of all the transactions that the firm enters into. Recognizing what qualifies as a transaction and making a record of the same is called bookkeeping. Bookkeeping is narrower in scope than accounting and concerns only the recording part. For the purpose of recording, accountants maintain a set of books. Their procedures are very systematic. Nowadays, computers have been deployed to automatically account for transactions as they happen. *Summarizing*- Recording for transactions creates raw data. Pages and pages of raw data are of little use to an organization for decision making. For this reason, accountants classify data into categories. These categories are defined in the chart of accounts. As and when transactions occur, two things happen, firstly an individual record is made and secondly the summary record is updated. For instance a sale to Mr. John for N1,000 would appear as: Sale to Mr. John for N1,000 Increases the total sales (summary) by 1,000 *Reporting*- Management is answerable to the investors about the company's state of affairs. The owners need to be periodically updated about the operations that are being financed with their money. For this reason, there are periodic reports which are sent to them. Usually the frequency of these reports is quarterly and there is one annual report which summarizes the performance of all four quarters. Reporting is usually done in the form of financial statements. These financial statements are regulated by government bodies to ensure that there is no misleading financial reporting. *Analyzing*- Lastly, accounting entails conducting an analysis of the results. After results have been summarized and reported, meaningful conclusions need to be drawn. Management must find out its positive and negative points. Accounting helps in doing so by means of comparison. It is common practice to compare profits, cash, sales, assets, etc of one period with another to analyze the performance of the business. ### 1.1.1 Accounting as a field of Study and Profession Accounting is also a field of study and profession dedicated to carrying out those tasks. The financial statements that summarize a large company\'s operations, financial position, and cash flows over a particular period are concise and consolidated reports based on thousands of individual financial transactions. As a result, all accounting designations are the culmination of years of study and rigorous examinations combined with a minimum number of years of practical accounting experience. While basic accounting functions can be handled by a bookkeeper, advanced accounting is typically handled by qualified accountants who possess designations such as Chartered Accountant (CA) and Certified National Accountants (CNA) in Nigeria, [Certified Public Accountant](https://www.investopedia.com/terms/c/cpa.asp) (CPA) or Certified Management Accountant (CMA) in the United States and Certified Chartered Accountant (CCA) in UK. In Canada, the designations are Chartered Accountant (CA), Certified General Accountant (CGA), and Certified Management Accountant (CMA). ### 1.1.2 Components of Accounting Accounting consists of two main branches/parts- namely: financial accounting and management accounting a. **Financial Accounting**: This branch deals with the preparation of financial statements for the use of outsiders like creditors, banks, government etc. The principal purpose of financial accounting is the show the profit or loss made by the organization and its financial position **Book --keeping** is an important component of financial accounting without which the purpose of financial accounting can be achieved i. How much capital is invested by the owners in the business? ii. How much does the business owe the employees, suppliers, banks, tax authorities etc? iii. How much does each customer owe the business? iv. How profitable is the business? b. **Management accounting,** also known as managerial accounting, provides information to management for analysis, decision making, planning and control of the business. For example, information relating to investment decisions, budgeting and performance measurement. It is meant to provide information of internal use by the management. Cost accounting provides the foundation for a functional management accounting system. Cost accounting deals with the ascertainment of cost of products and services to assist management in controlling its costs. 1.2 Book-Keeping and Accounting ------------------------------- All activities of entities whether they are business activities or non-business activities including organizations like schools universities , hospitals, libraries, clubs, societies , political parties 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. **However, Accounting** involves the process of identifying, measuring, recording, and communicating economic information about an organization or other entity, in order to permit informed judgments by users of the information. On the other hand, Book-keeping encompasses the record-keeping aspect of accounting. ### 1.2.1 Meaning and Definition of Book- Keeping **Book- keeping** includes recording of journal, posting in ledgers and balancing of accounts. All the records before the preparation of trial balance are the whole subject matter of book- keeping. Thus, book- keeping may 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 of the business that can be expressed in monetary terms are recorded in the books of accounts. Book- keeping can also be defined as 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. **Box 1.2: Definition of Book-keeping** Book- keeping is the art and science 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. ### 1.2.2. Objectives of Book- keeping The following are the objectives of book keeping: 1. Book- keeping provides a permanent record of each transaction. 2. Soundness of a firm can be assessed from the records of assets and abilities on a particular date. 3. Entries related to incomes and expenditures of a concern facilitate to know the profit and loss for a given period. 4. It enables to prepare a list of customers and suppliers to ascertain the amount to be received or paid. 5. It is a method that gives opportunities to review the business policies in the light of the past records. 6. Amendment of business laws, provision of licenses, assessment of taxes etc. are based on records. ### 1.2.3 Distinctions between Book-Keeping and Accounting The differences between book-keeping and accounting can be summarized in a tabular form as shown in Table 1.1 below: **Table 1.1: Distinction between Book-Keeping and Accounting** +-----------------------+-----------------------+-----------------------+ | **Basis of | **Book keeping** | **Accounting** | | difference** | | | +=======================+=======================+=======================+ | Transactions | Recording of | To examine these | | | transactions in books | recorded transactions | | | of original entry | in order to find out | | | | their accuracy | +-----------------------+-----------------------+-----------------------+ | Posting | To make posting in | To examine this | | | ledger | posting in order to | | | | | | | | ascertain its | | | | accuracy | +-----------------------+-----------------------+-----------------------+ | Total and Balance | To make total of the | To prepare trial | | | amount in journal and | balance with the help | | | account of ledger. To | of balances of ledger | | | ascertain balance in | accounts | | | all the accounts. | | +-----------------------+-----------------------+-----------------------+ | Income statement and | Preparation of | Preparation of | | Balance sheet | trading, Profit & | trading, profits and | | | loss account and | loss account and | | | balance sheet is not | balance sheet is | | | book keeping | included in it | +-----------------------+-----------------------+-----------------------+ | Rectification of | These are not | These are included in | | errors | included in | Accounting | | | book-keeping | | +-----------------------+-----------------------+-----------------------+ | Special skill and | It does not require | It requires special | | knowledge | any special skill and | skill and knowledge | | | knowledge as in | | | | advanced countries | | | | this work is done by | | | | machines/computers | | +-----------------------+-----------------------+-----------------------+ | Liability | A book-keeper is not | An accountant is | | | liable for | liable for the work | | | accountancy work | of bookkeeper | +-----------------------+-----------------------+-----------------------+ 1.3 Purpose of Accounting ------------------------- Accounting has a wide range of uses. Although the objective of accounting may differ from business to business depending upon their specific requirements. However, the following are the general objectives of accounting. i. **Record Keeping**- This is otherwise referred to as book-keeping function of accounting. The book-keeping aspect of accounting provides organizations with the systems of recording, classifying and summarizing their financial transactions in order aid the presentation their financial statements Organizations need to have a reliable and systematic way of recording financial information. Accounting is necessary to ensure that those running the business have a reliable record of financial transactions. ii. **Legal Requirement and Representation-** Accounting helps organizations to determine their financial rights and obligations. Without proper accounting, it would be very difficult for a business to account for and establish the rights and obligations of the various stakeholders of a business in terms of capital, asset, liabilities etc. Accounting is therefore necessary for a business to fulfill its legal obligations and asserting its own legal rights. Entities such as companies, societies, and trusts are compulsorily required to maintain accounts as required by the law governing their operations such as the Companies and Allied Matters Act, Societies Act, and Public Trust Act etc. Maintenance of accounts is also compulsory under the Sales Tax Act and Income Tax Act. iii. **Performance Analysis-** Accounting is used to generate the financial statements which can be used to ascertain the results of operations of the business over a specified period. Business owners can assess the performance over the business. This can be achieved based on the information contained in the statement of profit or loss account or income and expenditure account by matching items of revenue and expenditure over the same period. iv. **Ascertain the financial position of the business** - Accounting information is summarized to produce financial statements. Financial Statements provide an overview of the financial activities of a business during a period *(e.g. cash flow, income and expenses during the year)* as well as information about its financial position on a specific date *(e.g. amount of cash, inventory, assets, indebtedness and capital at the end of the year)*. 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. v. **Portray the liquidity position:** Financial reporting should provide information about how an enterprise obtains and spends cash, about its borrowing and repayment of borrowing, about its capital transactions. It provided information about the structure of the firm's assets and implications on the liquidity and solvency of the business. vi. **Protect business assets:** Accounting provides up to date information about the various assets that the firm possesses and the liabilities the firm owes. This makes it difficult for people to make false claim over the business assets. vii. **Planning and Control**- Accounting helps organizations to plan their finances by developing budgets and forecasts. Variance analysis provides a mechanism for the monitoring of expenses incurred by organizations by comparison with the budgeted expenditure. This process helps organizations in planning their finances ahead and controlling any deviations from the budget. viii. **Decision Making**- Accounting provides a basis for managerial decisions. Such decisions may include- investment appraisal, make or buy decisions The analysis of income statement and statement of financial position of the business can guide investment decisions *(e.g. whether they should invest more in the business, diversify or dispose their investment)*. 1.4 Users and Uses of Accounting Information -------------------------------------------- ### 1.4.1 Importance of Accounting Below are some of the users and the importance of accounting to their respective users: **Owners:** The owners provide funds or capital for the organization. They possess curiosity in knowing whether the business is being conducted on sound lines or not and whether the capital is being employed properly or not. Owners, being businessmen, always keep an eye on the returns from the investment. Comparing the accounts of various years helps in getting good pieces of information. **Management:** The management of the business is greatly interested in knowing the position of the firm. The accounts are the basis, the management can study the merits and demerits of the business activity. Thus, the management is interested in financial accounting to find whether the business carried on is profitable or not. The financial accounting is the "eyes and ears of management and facilitates in drawing future course of action, further expansion etc." **Creditors:** Creditors are the persons who supply goods on credit, or bankers or lenders of money. It is usual that these groups are interested to know the financial soundness before granting credit. The progress and prosperity of the firm, two which credits are extended, are largely watched by creditors from the point of view of security and further credit. Profit and Loss Account and Balance Sheet are nerve centres to know the soundness of the firm. **Employees:** Payment of bonus depends upon the size of profit earned by the firm. The more important point is that the workers expect regular income for the bread. The demand for wage rise, bonus, better working conditions etc. depend upon the profitability of the firm and in turn depends upon financial position. For these reasons, this group is interested in accounting. **Investors:** The prospective investors, who want to invest their money in a firm, of course wish to see the progress and prosperity of the firm, before investing their amount, by going through the financial statements of the firm. This is to safeguard the investment. For this, this group is eager to go through the accounting which enables them to know the safety of investment. **Government:** Government keeps a close watch on the firms which yield good amount of profits. The state and central Governments are interested in the financial statements to know the earnings for the purpose of taxation. To compile national accounting is essential. **Consumers:** These groups are interested in getting the goods at reduced price. Therefore, they wish to know the establishment of a proper accounting control, which in turn will reduce to cost of production, in turn less price to be paid by the consumers. Researchers are also interested in accounting for interpretation. **Research Scholars:** Accounting information, being a mirror of the financial performance of a business organization, is of immense value to the research scholar who wants to make a study into the financial operations of a particular firm. To make a study into the financial operations of a particular firm, the research scholar needs detailed accounting information relating to purchases, sales, expenses, cost of materials used, current assets, current liabilities, fixed assets, long-term liabilities and share-holders funds which is available in the accounting record maintained by the firm. ### 1.4.2 Functions of Accounting Below are some of the functions of accounting: - Record keeping function - Managerial function - Legal requirement function - Language of Business **Record Keeping Function:** The primary function of accounting relates to recording, classification and summary of financial transactions-journalisation, posting, and preparation of final statements. These facilitate to know operating results and financial positions. The purpose of this function is to report regularly to the interested parties by means of financial statements. Thus, accounting performs historical function i.e., attention on the past performance of a business; and this facilitates decision making programme for future activities. **Managerial Function:** Decision making programme is greatly assisted by accounting. The managerial function and decision making programme, without accounting, may mislead. The day-to-day operations are compared with some predetermined standard. The variations of actual operations with pre-determined standards and their analysis are possible only with the help of accounting. **Legal Requirement function:** Auditing is compulsory in case of registered firms. Auditing is not possible without accounting. Thus, accounting becomes compulsory to comply with legal requirements. Accounting is a base and with its help, various returns, documents, statements etc., are prepared. **Language of Business:** Accounting is the language of business. Various transactions are communicated through accounting. There are many parties-owners, creditors, government, employees etc., who are interested in knowing the results of the firm and this can be communicated only through accounting. The accounting shows a real and true position of the firm or the business. ### 1.4.3 Advantages and Disadvantages of Accounting Below are the advantages and disadvantages of accounting: **Advantages of Accounting** The following are the advantages of accounting to a business: 1. It helps in having complete record of business transactions. 2. It gives information about the profit or loss made by the business at the close of a year and its financial conditions. 3. It provides useful information for making economic decisions. 4. It facilitates comparative study of current year's profit, sales, expenses etc., with those of the previous years. 5. It supplies information useful in judging the management's ability to utilize enterprise resources effectively in achieving primary enterprise goals. 6. It provides users with factual and interpretive information about transactions and other events which are useful for predicting, comparing and evaluation the enterprise's earning power. 7. It helps in complying with certain legal formalities like filing of income tax and sales-tax returns. ### 1.4.4 Limitations of Accounting The following are limitations or disadvantages of accounting; 1. Accounting is historical in nature: It does not reflect the current financial position or worth of a business. 2. Transactions of non-monetary mature do not find place in accounting. Accounting is limited to monetary transactions only. Thus, it excludes qualitative elements like management, reputation, employee morale, labour strike etc. 3. Facts recorded in financial statements are greatly influenced by accounting conventions and personal judgments of the Accountant or Management. 4. Accounting principles are not static or unchanging-alternative accounting procedures are often equally acceptable. Therefore, accounting statements do not always present comparable data. 5. Cost concept is found in accounting. Price changes are not considered. Money value is bound to change often from time to time. This is a strong limitation of accounting. 6. Accounting statements do not show the impact of inflation. 7. The accounting statements do not reflect those increases in net asset values that are not considered realizable. **Summary of Study Session 1** ------------------------------ In this study session, you have learned the following: 1. Accounting is concerned with the recording, classifying, summarizing and communicating the financial information of an entity to interested parties and interpreting in order to aid business decisions. 2. **Book- keeping** includes recording of journal, posting in ledgers and balancing of accounts. All the records before the preparation of trial balance are the whole subject matter of book- keeping. 3. The differences between book-keeping and accounting. 4. Accounting consists of two main branches/parts- namely: financial accounting and management accounting. 5. Accounting has a wide range of uses. Although the objective of accounting may differ from business to business depending upon their specific requirements. 6. There are various functions of accounting in the modern day business environment which include language of business among others. Glossary of Terms ----------------- **Accountant** is a professional who performs accounting functions such as audits or financial statement analysis. **Accounting information** is a data about a business entity's transactions. They are the data that arises from business transactions. **Internal users** refer to the people in the organization producing the accounting reports. **External users** are the people, institutions and entities outside the organization's boundaries that use the information for the purpose of decision-making.