Acknowledgement 1

INTRODUCTION TO ACCOUNTING

NATURE OF ACCOUNTING
Accounting is defined as the process of identifying, measuring and reporting economic
information to the users of this information to permit informed judgment

Definition by the American Institute of Certified Public

Accountants (Year 1961):
“Accounting is the art of recording, classifying and summarizing in a significant manner and in
terms of money, transactions and events which are, in part at least, of a financial character, and
interpreting the result thereof.

Many businesses carry out transactions. Some of these transactions have a financial implication
i.e. either cash is received or paid out. Examples of these transactions include selling goods, buying
goods, paying employees and so many others.
Accounting is involved with identifying these transactions measuring (attaching a value) and
reporting on these transactions. If a firm employs a new staff member then this may not be an
accounting transaction. However when the firm pays the employee salary, then this is related to
accounting as cash involved. This has an economic impact on the organization and will be recorded
for accounting purposes. A process is put in place to collect and record this information; it is then
classified and summarized so that it can be reported to the interested parties.

Objectives of Accounting

(i) Providing Information to the Users for Rational Decision-making

The primary objective of accounting is to provide useful information for decision-

making to stakeholders such as owners, management, creditors, investors, etc. Various
outcomes of business activities such as costs, prices, sales volume, value under ownership,
return of investment, etc. are measured in the accounting process. All these accounting
measurements are used by stakeholders (owners, investors, creditors/bankers, etc.) in
course of business operation. Hence, accounting is identified as ‘language of business’.

(ii) Systematic Recording of Transactions

To ensure reliability and precision for the accounting measurements, it is necessary to

keep a systematic record of all financial transactions of a business enterprise which is
ensured by bookkeeping. These financial records are classified, summarized and reposted
in the form of accounting measurements to the users of accounting information i.e.,
stakeholder.

(iii) Ascertainment of profit and loss

‘Profit/loss’ is a core accounting measurement. It is measured by preparing statement of
comprehensive income for a particular period. Various other accounting measurements
such as different types of revenue expenses and revenue incomes are considered for
preparing this income statement. Difference between these revenue incomes and revenue
expenses is known as result of business transactions identified as profit/loss.

(iv) Ascertain the Financial Position of Business

‘Financial position’ is another core accounting measurement. Financial position is

identified by preparing a statement of ownership i.e., Assets and Owings i.e., liabilities of
the business as on a certain date. This statement is popularly known as Statement of
Financial position..

(v) To Know the Solvency Position

Statement of Financial position and statement of comprehensive income prepared as above give
useful information to stockholders regarding concerns potential to meet its obligations in the
short run as well as in the long run

a) USERS OF ACCOUNTING INFORMATION

i. Owners:
They have invested in the business and examples of such owners include sole traders,
partners (partnerships) and shareholders (company). They would like to have information
on the financial performance, financial position and changes in financial position.
This information will enable them to assess how the managers of the business are
performing whether the business is profitable or not and whether to make drawings or put
in additional capital.

ii. Customers
Customers rely on the business for goods and services. They would like to know how the
business is performing and its financial position.
This information would enable them to assess whether they can rely on the firm for future
supplies.
iii. Suppliers
They supply goods or services to the firm. The supplies are either for cash or credit. The
suppliers would like to have information on the financial performance and position so as
to assess whether the business would be able to pay up for the goods and services
provided as and when the payments falls due.

iv. Managers
The managers are involved in the day-to-day activities of the business. They would like
to have information on the financial position, performance and changes in financial
position so as to determine whether the business is operating as per the plans.In case the
 plan is not achieved then the managers come up with appropriate measures (controls) to
ensure that the set plans are met.
v. The Lenders
They have provided loans and others sources of capital to the business. Such lenders
include banks and other financial institutions. They would like to have information on the
financial performance and position of the business to assess whether the business is
profitable enough to pay the interest on loans and whether it has enough resources to pay
back the principal amount when it is due.
vi. The Government and its agencies
The Government is interested in the financial performance of the business to be able to
assess the tax to be collected in the case there are any profits made by the business.
The other government agencies are interested with the financial position and performance
of the business to be able to come with National Statistics. This statistics measure the
average performance of the economy.

vii. The Financial Analyst and Advisors

Financial analyst and advisors interpret the financial information. Examples include
stockbrokers who advise investors on shares to buy in the stock market and other
professional consultants like accountants. They are interested with the financial position
and performance of the firm so that they can advise their clients on how much is the
value their investment i.e. whether it is profitable or not and what is the value.
Others advisors would include the press who will then pass the information to other
relevant users.

viii. The Employees

They work for the business/entity. They would like to have information on the financial
position and performance so as to make decisions on their terms of employment. This
information would be important as they can use it to negotiate for better terms including
salaries, training and other benefits.
They can also use it to assess whether the firm is financially sound and therefore their
jobs are secure.
ix. The Public
Institutions and other welfare associations and groups represent the public. They are
interested with the financial performance of the firm. This information will be important
for them to assess how socially responsible is the firm. This responsibility is in form the
employment opportunities the firm offers, charitable activities and the effect of firm’s
activities on the environment.
THE ACCOUNTING EQUATION
A business owns properties. These properties are called assets. The assets are the business
resources that enable it to trade and carry out trading. They are financed or funded by the owners
of the business who put in funds.
These funds, including assets that the owner may put is called capital. Other persons who are not
owners of the firm may also finance assets. Funds from these sources are called liabilities.
The total assets must be equal to the total funding i.e. both from owners and non-owners. This is
expressed inform of accounting equation which is stated as follows:
ASSETS = LIABILITIES + CAPITAL
Each item in this equation is briefly explained below.
Assets:
An asset is a resource controlled by a business entity/firm as a result of past events for which
economic benefits are expected to flow to the firm.
An example is if a business sells goods on credit then it has an asset called a debtor. The past
event is the sale on credit and the resource is a debtor. This debtor is expected to pay so that
economic benefits will flow towards the firm i.e. in form of cash once the customers pays.
Assets are classified into two main types:
i) Non current assets (formerly called fixed assets).
ii) Current assets.
Non current assets are acquired by the business to assist in earning revenues and not for resale.
They are normally expected to be in business for a period of more than one year.
Major examples include:
▪ Land and buildings
▪ Plant and machinery
▪ Fixtures, furniture, fittings and equipment
▪ Motor vehicles
Current assets are not expected to last for more than one year. They are in most cases directly
related to the trading activities of the firm. Examples include:
▪ Stock of goods – for purpose of selling.
▪ Trade debtors/accounts receivables – owe the business amounts as a resort of trading.
▪ Other debtors – owe the firm amounts other than for trading.
▪ Cash at bank.
▪ Cash in hand.
Liabilities:
These are obligations of a business as a result of past events settlement of which is expected
to result to an economic outflow of amounts from the firm. An example is when a business
buys goods on credit, then the firm has a liability called creditor. The past event is the credit
purchase and the liability being the creditor the firm will pay cash to the creditor and
therefore there is an out flow of cash from the business.
Liabilities are also classified into two main classes.
i) Non-current liabilities (or long term liabilities)
ii) Current liabilities.
Non-current liabilities are expected to last or be paid after one year. This includes long-term
loans from banks or other financial institutions. Current liabilities last for a period of less
than one year and therefore will be paid within one year. Major examples:
▪ Trade creditors/
 or accounts payable – owed amounts as a result of business buying goods on
credit.
▪ Other creditors - owed amounts for services supplied to the firm
other than goods.
▪ Bank overdraft - amounts advanced by the bank for a short-term
period.
Capital:
This is the residual amount on the owner’s interest in the firm after deducting liabilities
from the assets. The Accounting equation can be expressed in a simple report called the
Statement of Financial position.

ACCOUNTING CYCLE

When complete sequence of accounting procedure is done which happens frequently

and repeated in same directions during an accounting period, the same is called an
accounting cycle.

Steps/Phases of Accounting Cycle

The steps or phases of accounting cycle can be developed as under:
 TYPES OF ACCOUNTS

(1) Personal Account: As the name suggests these are accounts related to persons.
(a) These persons could be natural persons like Suresh’s A/c, Anil’s
a/c, Rani’s A/c etc.
(b) The persons could also be artificial persons like companies, bodies corporate or
association of persons or partnerships etc. Accordingly, we could have Videocon
Industries A/c, Infosys Technologies A/c, Charitable Trust A/c, Ali and Sons trading
A/c, ABC Bank A/c, etc.
(c) There could be representative personal accounts as well. Although the individual
identity of persons related to these is known, the convention is to reflect them as
collective accounts. e.g. when salary is payable to employees, we know how much is
payable to each of them, but collectively the account is called as ‘Salary Payable
A/c’. Similar examples are rent payable, Insurance prepaid, commission pre-received
etc. The students should be careful to have clarity on this type and the chances of
error are more here.

(2) Real Accounts: These are accounts related to assets or properties or possessions.
Depending on their physical existence or otherwise, they are further classified as
follows:-
(a) Tangible Real Account – Assets that have physical existence and
can be seen, and touched. e.g.
Machinery A/c, Stock A/c, Cash A/c, Vehicle A/c, and the like.
(b) Intangible Real Account – These represent possession of properties
that have no physical existence but can be measured in terms of
money and have value attached to them. e.g. Goodwill A/c, Trade
mark A/c, Patents & Copy Rights A/c, Intellectual Property Rights
A/c and the like.

(3) Nominal Account: These accounts are related to expenses or losses and
incomes or gains e.g. Salary and
Wages A/c, Rent of Rates A/c, Travelling Expenses A/c, Commission
received A/c, Loss by fire A/c etc.
 Double Entry Aspects
The Accounting equation forms the basis of double entry and therefore it should always be
maintained. Any change in assets, liabilities or capital will have a double effect such that assets
will always be equal to liabilities plus capital. If the owners put in additional capital then this will
increase the cash at bank and the capital amount therefore the equation is still maintained.
Name of the Account
Debit Credit
Date Detail Folio Amount Date Detail Folio Amount

In this account the date will show the opening period of the asset , liability or capital i.e. the balance
brought forward. It will also show the date when a transaction took place (i.e. either an asset was
bought or liability incurred).
The detail column (also called the particulars column) shows the nature of the transaction and
reference to the corresponding account. The Folio Column for purposes of detailed recording
shows the reference number of the corresponding account. The amount column shows the amount
of the asset, liability or capital.
The left side of the account is called the debit side and the right side is called the credit side. All
assets are shown or recorded on the debit side while all the liabilities and capital are recorded on
the credit side. Each type of asset or liability must have its own account whereby all transactions
affecting them are recorded in this account. Therefore there should be an account for Premises,
Plant and Machinery, Stock, Debtors, Creditors etc.
Under the accounting equation if all assets are represented by liabilities and capital therefore all
debits should be the same as credits.
For the double entry to be reflected in the accounts, every debit entry must have a corresponding
credit entry. The transactions affecting these accounts are posted in the account as debit entry and
credit entry to complete the double entry.
When we make a debit entry we are either:
i. Increasing the value of an asset.
ii. Reducing the value of a liability.
iii. Reducing the value of capital.
When we make a credit entry we are either:
i. Reducing the value of an asset.
ii. Increasing the value of a liability.
iii. Increasing the value of capital.

Balancing off Accounts

1. Sum the entries on the larger side below the line

2. Repeat the sum below the line on the other side

3. Strike the balance: insert the amount missing such that the sums of entries on both sides
are equal (i.e. solving the account equation)

The amount missing is called Balance carried forward or Balance carried down
labelled as bal c/f or bal c/d
While opening a new account in the next period this missing figure will be labelled as
Balance brought forward or Balance brought down labelled as bal b/f or bal
b/d

Accounting for sales, purchases, incomes and expenses.

Sales:
This is the sell of goods that were bought by a firm (the goods must have been bought with the
purpose of resale). Sales are divided into cash sales and credit sales. When a cash sale is made,
the following entries are to be made.
i. Debit cash either at bank or in hand.
ii. Credit sales account.
For a credit sale:
i. Debit debtors/ Accounts receivable account.
ii. Credit sales account.
A new account for sales is opened and credited with cash or credit sales.
Purchases:
Buying of goods meant for resale. Purchases can also be for cash or on credit. For cash purchases:
i. Debit purchases.
ii. Credit cash at bank/cash in hand
For credit purchases, we:
i. Debit purchases.
ii. Credit creditors for goods.
A new account is also opened for purchases where both cash and credit purchases are posted.
NOTE: NO ENTRY IS MADE INTO THE STOCKS ACCOUNT.
Incomes:
A firm may have other incomes apart from that generated from trading (sales). Such incomes
include:
▪ Rent
▪ Bank interest
▪ Discounts received.
When the firm receives cash, from these incomes, the following entries are made:
▪ Debit cash in hand/at bank.
▪ Credit income account.
Each type of income should have its own account e.g. rent income, interest income.
Incomes increase the value of capital and that is the reason why they are posted on the credit side
of their respective accounts.
Expenses:
These are amounts paid out for services rendered other than those paid for purchases. Examples
include:
• Postage and stationery
• Salaries and wages
• Telephone bills
• Motor vehicle running expenses.
• Bank charges.
When a firm pays for an expense, we:
i. Debit the expense account.
ii. Credit cash at bank/in hand.
Each expense should also have its own account where the corresponding entry will be posted.
Expenses decrease the value of capital and thus the posting is made on the debit side of their
accounts.
Accounting for drawings, discounts allowed and discounts received.
Drawings
The owner makes drawings from the firm in various ways:

i) Cash or bank withdrawals

When the owner withdraws money from the business we debit drawings and credit cashbook (cash
in hand or cash at bank).
ii) Taking goods for own use and
When the owner takes out some of the goods for his own use, we debit drawings and credit
purchases.
iii) Personal expenses, paid by the business
Here we debit the drawings and credit expense account
Taking some of the other assets from the business e.g. motor vehicles or using part of the premises.
Sometimes the owner may take over some of the assets of the business e.g. vehicle or converting
business premises into living quarters or not paying into the business cash collected personally
from the customers. When this happens we debit drawings and credit the relevant asset e.g. motor
vehicles, premises or some building or even debtors.
Example (Solved with the Lecturer)
Enter the following transactions, completing the double entry in the books of Jane Masai for the
month of May 2021.
2021
May 1 Started business with sh.2,000 in the bank.
“ 2 Purchased goods sh.175 on credit from M Roko.
“ 3 Bought furniture and fittings sh.150 paying by cheque.
“ 5 Sold goods for cash sh.275.
“ 6 Bought goods on credit sh.114 from P. Solo.
“ 10 Paid rent by cash sh 15.
“ 12 Bought stationery sh 27, paying in cash.
“ 18 Goods returned to M Roko sh 23.
“ 21 Let off part of the premises receiving rent by cheque sh.5.
“ 23 Sold goods on credit to U Fatuma for sh.77.
“ 24 Bought a motor van paying by cheque sh.300.
“ 30 Paid the month’s wages by cash sh.117.
“ 31 The proprietor took cash for himself sh.44.

TRIAL BALANCE
The trial balance is a simple report that shows the list of account balances classified as per the
debits and credits. The purpose of the trial balance is to show the accuracy of the double entries
made and to facilitate the preparation of final accounts i.e. the trading, profit & loss account and
a balance sheet.
The debits of the trial balance should be the same as the credits, if not then there is an error in one
or more of the accounts.
NB// From the trial balance please note that assets and expenses are on the debit side. Capital, liabilities and
incomes are normally listed on the credit side.
The trial balance to be prepared from example 1 Above:

.
Example 2 Group Assignment 1)
Write up the following transactions in the books of S Pink and Extract a trial Balance
2003
March 1 Started business with cash £1,000.
“ 2 Bought goods on credit from A Cliks £296.
“ 3 Paid rent by cash £28.
“ 4 Paid £1,000 of the cash of the firm into a bank account.
“ 5 Sold goods on credit to J Simpson £54.
“ 7 Bought stationery £15 paying by cheque.
“ 11 Cash sales £49.
“ 14 Goods returned by us to A Cliks £17.
“ 17 Sold goods on credit to P Lutz £29.
“ 20 Paid for repairs to the building by cash £18.
“ 22 J Simpson returned goods to us £14.
“ 27 Paid A Cliks by cheque £279.
“ 28 Cash purchases £125.
“ 29 Bought a motor vehicle paying by cheque £395.
“ 30 Paid motor expenses in cash £15.
“ 31 Bought fixtures £120 on credit from R west.

(Example 3 Group Assignment 1)

Brian Barmouth is a sole trader. At 30 June 2000 the following balances have been
extracted from his books:

£
Sales 47,600.00
Purchases 22,850.00
Office expenses 1,900.00
Insurance 700.00
Wages 7,900.00
Rates 2,800.00
Heating and Lighting 1,200.00
Telephone 650.00
Discounts allowed 1,150.00
Opening stock 500.00
Returns inwards 200.00
Returns outwards 150.00
 Premises 40,000.00
Plant and Machinery 5,000.00
Motor Vehicles 12,000.00
Debtors 12,500.00
Bank balance 7,800.00
Creditors 3,400.00
Loan-long term loan 10,000.00
Capital 60,000.00
Drawings for the year 4,000.00
Closing stock 550.00

Required:
Construct a trial balance, from the above list of balances
1.