Unit 1

Introduction to accounting
and accounting equation
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What is accounting
It is a systematic process of identifying,
recording, measuring, classifying, verifying,
summarizing, interpreting and
communicating financial information.

Accounting is a process
Collection in money terms of information
relating to transactions that have resulted
from business operations
Recording and classifying data into a
permanent and logical form. This is usually
referred to as "Book-keeping
Summarizing data to produce statements
and reports that will be useful to the
various users of accounting information both external and internal
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Accounting is a
communication device
Aim is to provide accounting
information that can be communicated
to a range of people and institutions
who will then make use of this
information.

Users of accounting
information
Two categories
Internal users

Owners of the business

Employees
Managers

External users

Regulatory authorities
Suppliers
Customers
Bankers
Competitors
Community groups
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Accounting information is communicated

using "financial statements"
There are two main purposes of financial statements:
(1) To report on the financial position of an entity (e.g. a
business, an organisation);
(2) To show how the entity has performed (financially) over
a particularly period of time (an "accounting period").
The most common measurement of "performance" is profit.

Types of accounting
Financial Accounting
Management Accounting

Financial Accounting
Reporting of the financial position (the
statement of financial position) and
performance (the profit and loss
account and cash flow statement) of a
firm through financial statements issued
to external users

Management accounting
Management accounting is concerned with
the provisions and use of accounting
information to managers within organizations,
to provide them with the basis to make
informed business decisions that will allow
them to be better equipped in their
management and control functions.

Management Accounting
(Cont)
In contrast to financial accountancy
information, management accounting
information is:
designed and intended for use by managers
within the organization, whereas financial
accounting information is designed for use
by shareholders and creditors.
usually confidential and used by
management, instead of publicly reported;
forward-looking, instead of historical;
computed by reference to the needs of
managers
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Activity 1
Which stakeholder
group...

would be most interested in...

A: the VAT and other tax liabilities of the

firm
B: the potential for pay awards and
bonus deals
C: the ethical or environmental activities
of the firm
D: whether the firm has a long-term
future
E: profitability and share performance
F: the ability of the firm to carry on
providing a service or producing a
product
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The accounting equation

For a business to start up, it needs funds
The business will then use the funds to acquire
resources known as assets
Assets things the company owns or
resources that a business uses in the
production of goods and services.
Funds come from two sources:
the owner's past savings (known as owners
equity or capital)
and/or borrowings (known as debt capital
or liabilities)
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The accounting equation

defined
The accounting equation states
that the value of all the resources
owned by a business, that is the
assets, must equal the value of all
the money introduced into or
owned by the business, i.e. capital
and liabilities
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The accounting equation

When the assets have been supplied by the
owners own capital then the following
accounting information will hold:Assets = Owners Equity (Capital)

The accounting equation for a corporation is:

Assets = Liabilities + Stockholders Equity

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The accounting equation

Some of the assets will normally
have been provided by someone
other than the owner
Indebtedness of the owner for
these resources is known as
liabilities.
The equation can be expressed as
Assets = capital + liabilities
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The accounting equation

rearranged
The equation can be rearranged so as to
enable the calculation of missing figures:

Assets = Capital + Liabilities

Capital = Assets Liabilities
Liabilities = Assets - Capital
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Activity 2
Distinction between assets, liabilities
and capital
Assets
a)
b)

12,000
?

Liabilities

Capital

4,000

6,000

5,000

c)

16,000

12,000

d)

28,000

4,000

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Activity 3- Classification of
assets and liabilities
Distinguish from the following list the
items that are assets from those that
are liabilities

Office machinery
Loan from Jones
Fixtures and fittings
Motor vehicles
We owe for goods
Bank balance
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Effects of transactions on
accounting equation
Business transactions affect both
sides of the accounting equation
Example 1
On June 2000, Rita set up a business producing computer
software for musicians. She provides Rs 2,000 capital from
her savings which she puts in her business bank account and
persuaded a bank to lend her business Rs 1,000 for two years.
With the money, she bought a computer for Rs 2,700 and
deposited the remaining Rs 300 in the bank. During the year
she did not undertake any other transactions
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The duality concept

Note that the total of the 'assets' side
equals the total of the other side
(again).
Note also that two items changed in
value when there was a transaction.
This rule is known as the dual aspect
concept.
It is these two effects that leads us to
use a double-entry book-keeping
system (Lecture 2).
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The Duality concept

(Cont)
The duality concept states that every transaction
has two effects on a businesss accounts.
Suppose that a business buys some goods on
credit for Rs 1,000
What is the effect on the accounting equation?

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Effect of transactions on
accounting equation
Example 2
On June 2000, Rita set up a business producing computer software
for musicians. She provides Rs 2,000 capital from her savings
which she puts in her business bank account and persuaded a
bank to lend her business Rs 1,000 for two years. With the money,
she bought a computer for Rs 2,700 and deposited the remaining
Rs 300 in the bank. On July 2000, she introduced another Rs 1,500
into the business and deposited it in bank during July.
The effect of this transaction on the business would be
An increase of capital by Rs 1,500, from Rs 2,000 to Rs 3,500
An increase in assets by Rs 1,500, from Rs 3,000 to Rs 4,500.
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The expanded accounting

equation
Revenue is the money that businesses
receive when selling their goods and
services to customers
Expenses are costs incurred in running
a business.
Drawings refers to money taken out of
a business by the owner for personal
use. The effect of drawings is to reduce
capital
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The expanded accounting

equation
The accounting equation can be expanded
to include revenue, expenses and
drawings.
The expanded accounting equation can be
expressed as follows:Assets = Capital + Liabilities + Revenue Expenses Drawings

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The expanded accounting equation

(Cont)
Expressed in words, this means that the total
resources owned by a business (Assts) equals
The money introduced from owners and creditors
(capital and liabilities)
Plus the money received from selling goods and
services (revenue)
Less the money spent on resources (expenses)
And the money taken out by the owner for personal
use (drawings)
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Activity 4
On June 2000, Rita set up a business producing computer software
for musicians. She provides Rs 2,000 capital from her savings which
she puts in her business bank account and persuaded a bank to lend
her business Rs 1,000 for two years. With the money, she bought a
computer for Rs 2,700 and deposited the remaining Rs 300 in the
bank. On July 2000, she introduced another Rs 1,500 into the
business and deposited it in bank during July. During the year, Rita
buys a car for her business for Rs 850, paying by cheque. During
September, Rita sells some software, banking a cheque of Rs 740.
She also has to incur expenses of Rs 230 for the transaction.
Rearrange the accounting equation to show the position of the
business on 30 September 2000.
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The accounting
equation and the
statement of financial
position (balance sheet)

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The statement of financial

position
The accounting equation shows the value
of resources owned by a business and the
sources of finance to acquire these
resources.
The same information forms the basis of a
financial statement known as the
statement of financial position
It is a list of assets and liabilities of a
business at a particular date.
Like the accounting equation, the
statement of financial position must always
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balance.

How to prepare the statement

of financial position
List and group the assets and
liabilities of the business under the
headings:Non current assets
Current assets
Current liabilities
Long-term liabilities
Capital
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Assets
An asset is something the business owns or controls such
as: Inventory (goods manufactured or purchased for resale)
Receivables (money owned by credit customers, prepaid
expenses)
Cash
Non-current assets

Presentation of current assets- To start with the most

illiquid asset first, e.g. Inventory, receivables, bank, cash in
hand
Non-current assets-any tangible or intangible asset
acquired on a long term basis to be used in providing
service to the business
They are not meant for resale in the normal course of
trading
Examples include Land and buildings, motor vehicles, plant
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and machinery

Liabilities

Current liabilities- items to be paid up

within one year
Examples include bank overdrafts,
accruals, creditors for the purchase of
goods for resale
Non-current liabilities- items that have to
be paid after more than a year.
Examples include bank loan, loans from
other businesses
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Statement of financial position as at (date)

Assets:

Rs

Rs

Non-current assets
Plant

Xxx

Machine

xxx
xxx

Current assets
Inventory

xxx

Debtors

xxx

Cash

xxx

Total assets

xxx
xxx

Equity and liabilities

Owners equity

xxx

Non-current liabilities
Loan

xxx

Current Liabilities

Bank overdraft
Total equity and liabilities

xxx
xxx

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Types of business
Sole trader
Partnership
Company

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Further reading
Frankwood business accounting 1- Chapters
1,2, 3, 4
Randell As Level and A level- Chapters 1 and 2
ACCA text book- Chapters 1 and 2

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