Introduction to Accounts


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

  • Prepare financial statements (Income statement and Statement of financial position
  • Compare financial statements of one year with another
  • Analyses financial performance
  • Prepare monthly report that analyses the profitability of the business
  • Advise on cost reduction and profit maximisation

What are the objectives of accounting?

  • To maintain a systematic record of all business transactions
  • To ascertain profit or loss of the business
  • To measure the performance of the business
  • To forecast the performance of the business
  • To provide information to managers for decision making

Who are the users of accounts/ accounting information?

Internal users

External users

  • Business owners
  • Government
  • Managers
  • Financial institutions-Bank
  • Employees
  • Customers
  • Existing investors
  • Suppliers

 

  • Competitors

 

  • Potential investors / General public

 

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

  • Sole proprietorship
  • Partnership
  • Company
  • Non profit making 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

  • Record financial transactions
  • Maintaining cash book and petty cash book
  • Record sales and purchase invoices
  • Extract balances from the ledger accounts to produce a trial balance
  • Provide information for decision-making

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:

  • Property, plant and equipment
  • Machinery
  • Motor vehicles
  • Land and Buildings
  • Fixtures and fittings

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:

  • Inventory of goods
  • Trade receivables (Credit customers)
  • Cash in hand/ cash at bank/ cash and cash equivalents / petty cash
  • Other receivables (Expenses paid in advance/income due)

 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:

  • Loan from bank
  • Loan from friend
  • Mortgage of premises

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:

  • Trade payables (Credit suppliers)
  • Other Payables (Expenses due / Income prepaid)
  • Bank overdraft (Bank – credit balance)

 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.

  • Debit Side (Dr)
  • Credit Side (Cr)

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

  1. Cash transaction
  2. Bank transaction
  3. Credit Transaction