What is accounting?
Accounting is the process of recording, classifying and summarizing business information in such a way that users understand. Accounting is performed periodically and relies on having accurate book-keeping records.
Accounts simply mean records. Since it is difficult to memorise all the money received and paid by the business it is easier to write them down. The financial events of a business are recorded in an account for further analysis and for reference in the future.
Tasks perform by an accountant
What are the objectives of accounting?
Who are the users of accounts/ accounting information?
Internal users | External users |
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What is a business?
A business is an organisation set up by a person, a family or a group, to produce and sells goods and services to customers with a view to make profit.
Forms of business
Trading business
Trading businesses are those that buy tangible (ready made/finished) products and sell them at a profit. Trading businesses sells a variety of products and maintain inventory of goods. For example, supermarket, furniture store and flower shop
Service business
A service business is an enterprise composed of a professional or team of experts that support, deliver work or help in completing a task for the benefit of its customers. For example, hairdressing salon, accountant’s practice and computer repair shop.
Manufacturing business
A manufacturing business is an organisation that uses raw materials, parts, and components to assemble finished goods. For example automotive company, bakeries and shoe maker.
Types of business organisations
Bookkeeping
Bookkeeping is a process used in accounting to record financial transactions of a business on a daily basis using the double entry principle. It involves preparing source documents for all transactions, operations, and other events of a business.
Tasks perform by a book-keeper
Accounting equation
The fundamental accounting equation represents the relationship between the assets, liabilities, and capital (owner's equity) of a business. The accounting equation essentially shows that what the firm owns (its assets) is purchased by either what it owes (its liabilities) or by its owners investment (capital). The accounting equation is the proposition that a company's assets must be equal to the sum of its liabilities and equity.
Assets = Capital + Liabilities
OR
Assets – Liabilities = Capital
Assets
An asset is a resource with economic value that a business owns with the expectation that it will provide a future benefit. There are two types of assets
Non current assets
These are acquired to be used in the business for a long period of time to increase the earning capacity of the entity. It is not purchased for resale. For example:
Current assets
Current assets are short-term economic resources that are expected to be converted into cash within one year. They are own by the business and their value changes almost everyday. For example:
Liabilities
Liabilities are debts or obligations the company owes as a result of past transactions. There are two types of liabilities:
Non current liabilities
These are amount of money owed by the business for a long period of time (usually more than one year). These are normally utilised to increase total capital of the business. For example:
Current liabilities
These are amount of money owed by the business for a short period of time (usually less than one year). They are mostly used for sustainability of working capital of the business. For example:
Capital
The capital of a business refers to the money used to start or expand an entity. It also refers to money available to pay for its day to day operations and to fund future growth. Capital may be in the form of assets brought in by the owner. It is known as owner’s equity.
The expanded accounting equation can be written as
ASSETS | = | Capital | + | Liabilities | ||||
Non current assets | + | Current assets | = | Owner’s equity | + | Non current liabilities | + | Current liabilities |
Non current assets + Current assets = Owner’s equity(Capital) + Non current liabilities + Current liabilities
Effects of transactions on accounting equation
Transactions | Assets | Capital | Liabilities |
Started business with cash $ 12 000 | Cash increase by $ 12 000 | Capital increase by $ 12 000 | |
Purchased goods by cash $ 1 100 | Inventory increase by $ 1100 Cash decrease by $ 1 100 | ||
Paid wages by cash $ 600 | Cash decrease by $ 200 | Wages – Expenses(Loss) Capital decrease by $ 200 | |
Sold goods for cash $ 2 500 | Inventory decrease by $ 2500 Cash increase by $ 2 500 | ||
Purchased equipment by cash $ 300 | Equipment increase by $ 300 Cash decrease by $ 300 | ||
Paid supplier by cash $ 200 | Cash decrease by $ 200 | Trade payables decrease by $ 200 |
NOTE:
Each transaction affects the accounting equation twice.
Double entry system
The accounting equation is a basic principle of accounting and sets the foundation of double-entry bookkeeping system. Double-entry accounting is a system where every transaction affects both sides of the accounting equation.
According to the double entry system each transaction must be recorded twice in the ledger. A ledger is a form used to record transactions of a business and it consists of two sides.
The dual aspect concept states that every business transaction must be recorded in two different accounts. It states that each debit entry must have a corresponding credit entry. There are 3 types of transactions
