ACCOUNTING

 Introduction

Accounting is the process of collecting, recording, summarising interpreting and communicating financial information to permit informed decisions. Accounts are the records in which financial information is contained. Accounting is a process, which involves the art of recording, classifying and summarising in a significant manner and in terms of funds, transactions, and events, which are, in part at least, of financial character and interpreting the results thereof.  All human organisations, requires written records which the management requires for day to day actions, decisions making and setting up procedures and relationships with other organisations or with individuals.  Money matters of the business are one of the most important aspects of records. This is the concern of financial accounting

Key Terms:

Accounting     The process of identifying, measuring, and communicating economic information to permit informed judgments and decisions

Bookkeeping: Routine records from day-to-day transaction in a prescribed form and according to set rules, of all events, which affect the financial state of a business.

Accounting

System:           An arithmetic model of the organisation financial state designed to registers every change in that state over time.

Accounting

equation:        An arithmetic formula used to prepare a balance sheet based on the logic

Assets - Liability = Capital

Accounting

policy :               the principles, bases, conventions, rules and practices applied by an entity that

                           specify how the effects of transactions and other events are to be presented in

                           its financial statements.

Accounting

postulates:         Fundamental ideas upon which the whole intellectual structure of accounting

                           discipline rests, and are not susceptible to proof within the framework thereof

Accounting

principles :        Fundamental ideas and assumptions that guide the preparation of accounting information and therefore underlying the construction of financial statements

Accounting defined

The American Accounting Association defines accounting as “The process of identifying, measuring, and communicating economic information to permit informed judgments and decisions.” This definition brings out a number of key elements:

i) Accounting is a tool of providing information to others. Accounting information relates to the financial or economic activities of the business or organization. It is thus economic information

ii) Accounting information needs to be identified and measured. This is done by a system of accounting

iii) Accounting information must be communicated to the users. There are many forms of (e.g. annual report and accounts, management accounting reports) each of which is designed to serve a different purpose.

Accounting can also be said to be is the process of collecting, recording, summarising interpreting and communicating financial information to permit informed decisions. This may be called the functional definition of accounting. The functional elements can be explained as follows:

Collection	Collection of information relating to business events
Recording	Recording and classifying data in a prescribed and systematic manner
Summarising	Summarising information contained in the system so as  to produce statements and reports that will be useful to the various users of accounting information
Interpreting and Communicating	Interpreting and communicating the performance of the business to the management and its owners

Accounts can be said to be the financial records of an organisation, articulated to form an accounting system and accounting as the activity of constructing and operating such a system.  This has two branches:

1)         Making of routine records from day-to-day transaction in a prescribed form and according to set rules, of all events, which affect the financial state of a business.

2)         Summarization of the information contained in the records, presentation of the information in significant form to interested parties and interpretation as an aid to decision making by these parties. The first task is bookkeeping while the second is accounting.

An accounting system forms an arithmetic model of the organisation financial state at all times, and registers every change in that state over time or rather such changes as the system is designed to register. An accounting system consists of personnel, procedures, devices and records used by an organisation which help in development and structure of accounting information and communicating this information to decision makers. Design and capabilities of these systems vary greatly from organisation to organisation. In very small organisations, the accounting systems may consist of little more than a cash book and a cheque book and may be an annual interaction with the public accountant for filing tax returns. In large organisations, accounting systems would include computers, expensive software, highly trained staff and periodic accounting reports that provide the backbone for controlling the daily functions of each department of the organisation. Still the basic purpose of the accounting system remains the same – that is “ to meet the organisation’s need for accounting information as efficiently as possible.”

It is necessary at this point to make a distinction between financial and management accounting.  Financial accounting (the subject of this course) is primarily concerned with communication of information to those who do not share in the management of the entity.  Financial Accounting is intended to serve the informational needs of external users who lack the authority to prescribe the financial information they want from an enterprise hence it’s concerned with reporting to users other than management. The objectives of financial accounting are to serve primarily those users who have limited authority, ability, or resources, to obtain information and who rely on financial statements as their principal source of information about an enterprise’s economic activities. Management accounting is a system designed to provide information to the enterprise managers so as to enable them run the business effectively and profitably.

ACCOUNTING THEORY

One common criticism against the discipline of accounting is its lack of a generally acceptable theory or group of theories as is found with other social sciences of economics origin. Academic accountants tend to lament the lack of generally accepted theory. However professional accountant seems to be rather happy with the status quo because they take theories and their construction to be work of academics. Professional accountants are comfortable and pleased that there is no generally agreed theory because they are suspicious that theories and their development may get into the way of real work.  Such a stand is an evidence of professional accountants ignorance of the role that theory plays in practical matters and do not realise that absence of theory give rise to many practical problems in the profession.

Accounting theory has been defined by the American Accounting Association as a “cohesive set of conceptual, hypothetical and pragmatic propositions explaining and guiding the accountants’ action in identifying, measuring and communicating economic information”.  It is the reasoning in the form of a set of broad principles that:

i)          Provide a general frame of reference by which accounting practice can be evaluated, and;

ii)         Guide to development of new practices and procedures.

  Therefore, the function of accounting theory is to guide and assist in the resolution of practical problems.  The existence of a theory would mean that, we could say and explain why given a number of assumptions, method X (e.g. current cost accounting) is to be preferred to method Y (e.g. historical cost accounting) There are many other areas in accounting in which theory helps to choose among alternatives. This includes depreciation, valuation of assets and liabilities, accounting for foreign currency and revenue recognition.

Accounting authority

            Users of Accounting information

A business should produce information about its activities to the interested parties.  People who might be interested in the financial needs of a business include the following:

a)                                     Shareholders (business owners). 

These are the investors. They would wish to know how efficiently the management is performing its steward function, that is, how profitably the management runs the business and how much profit they can afford to withdraw for their own use. They are also concerned about the ethical probity and sustainability of the business venture

b)                                     Management

 Management runs the business affairs on stewardship basis.  They need information about financial state of a business, current and future, so as to manage business efficiently and to make effective control and planning decisions. 

c)                                      Suppliers: 

When dealing with customers, Suppliers would wish to know the liquidity position of the firms, i.e. its ability to                                      meet its obligations as and when they fall due.  The Information needs of suppliers are similar to those of  investors and lenders

d)                                     Customers

 Customers would wish to be assured that the business is a steady source of supply. They do not wish to deal with a supplier who may end up collapsing or failing to deliver goods and services, as, and when they are required. Moreover, customers have become increasingly sensitive to their quality of the product and the due care taken in the production. They will support products that are produced in a socially acceptable manner and by businesses that have responded to social needs.

         e)                Lenders 

Lenders are interested in the solvency of the firm, ability to keep up with interest payments, and eventually to repay the principal. Lenders would want to know, about the quality of an entity's assets, its compliance with any loan  agreements, its technological status and its market place positioning , each which would affect the risk and the creditworthiness generally.

f)                Government: 

The operations and the results of the enterprise are of interest to the government. First the government would want to know about business profits in order to assess the tax payable. At the same time The government would want business to conduct their affairs in a socially acceptable manner and that they adhere to the  laws of the land.

g)             Employees:

Employees would want to know the results of the company so as use the same to negotiate for higher wages. They would also want to know whether the business is able to continue providing for remuneration and retirement benefits. Actually anything that can have an economic impact on the employers is of interest to the employees. They would want to see their employer’s business as a going concern with the ability to sustain their employment.

h)      General public

An enterprise is a member of the local community, customers, employees or shareholders. Any enterprises relates to the general public in one-way or the other.  Members of the public are increasingly concerned with the question whether businesses are socially responsive manner, from both a compliance with social norms and sustainability. Towards this end the general public would look for credible and understandable financial and non-financial information.

OBJECTIVES OF ACCOUNTING

The basic objective of financial statements is to provide information about the financial position, performance and financial adaptability of an enterprise that is useful to a wide range of users in making economic decisions.   Financial reporting should provide information that is useful to present and potential investors and creditors and other users in making rational investment, credit, and similar decisions.  The information should be comprehensible to those who have a reasonable understanding of business and economic activities and are willing to study the information with reasonable diligence.

Financial reporting should provide information about how management of an enterprise has discharged its stewardship responsibility to owners (stockholders) for the use of enterprise resources entrusted to it.

Other  objectives of accounting are:

1.         Internal Control:

            Including the safeguarding of organisations money and other property, the regular collection and payment of sums of money owing to and by it and prevention and detection of inefficiency, waste, dishonesty by employees of the organisation.

2          Measurement of Financial Data

            By means of recording of transactions and events affecting the financial state of the organisation and their processing in accordance with consistent rules.

3          Reporting of financial information to proprietors, investors and other interested persons, by presentation of annual or more frequent final accounts.

It is on the basis of these objectives that the theoretical structure of accounting is most rationally designed.

POSTULATE OF ACCOUNTING (AXIOMS)

These may be defined as the fundamental ideas upon which the whole intellectual structure of accounting discipline rests, and are not susceptible to proof within the framework thereof.  There are many such concepts but in the opinion of most authors, the following are the main ones:

i) Business entity      ii) Measurability  iii) Periodicity  iv) Dual Aspect

Business Entity

An entity is a being separate and distinct from its owners or managers.  An entity is best describe as  a group of Assets which been put together for a common purpose and of liabilities arising from the pursuit of that purpose, such assets being owned and liability owed by one person or two or more persons brought together by the common purpose aforesaid. The difference between the money values of the assets and of the liabilities is known as capital. If their initial letters denotes assets, liabilities and capital, the relationship may be stated algebraically as:

                        A-L=C

This forms the fundamental accounting equation on which the whole system of accounting rests.

Measurability

Accounting involves measurement of value. In order to render the components assets, liabilities and equity additive, it is necessary to reduce all these elements to a common measure; the only one applicable all round is money.  Hence all assets and liabilities of an entity are quantified (to the extent possible) in terms of single monetary unit and the equity thus remains the algebraic difference between the assets and liability thus expressed.  It is good to note that the accounts will only deal with those items that a monetary value can be attributed. 

Periodicity

It is assumed that the continuous lifetime of the entity can be broken down into specific time periods. The results of operation for each period (usually 12 months) can be measured and reported accordingly.  At the end of each period a" static" picture of the resources and the claims to those resources is taken.  This annual term is known as the financial year of the entity.

Dual aspect

Dual aspect means that for every change in any one element of the three components (Assets, Liability or Capital) there must be another change numerically equal but of opposite sign in another element or the other two elements put together. For instance increase in assets brought about by purchase of new plant is either a result of new capital introduced (increase in capital) or a result of borrowed money (increase in liabilities) or a combination of both owners capital and borrowed capital. This introduces the fundamental rule of bookkeeping that every debit is followed by a corresponding credit entry. A debit is a positive entry to the accounting system, which has the effect of increasing assets or reducing liabilities or equity. A credit is a negative entry to the accounting system, which has the effect of reducing assets or increasing liabilities or equity. Dual aspect postulate rest upon the entity postulate in that equity( ie capital)  is defined as to the diffrence between  assets and liabilities (ie A-L= C)

The numerical increase to the three components (∆A, ∆L, ∆E,) representing change in Assets, Liabilities and Equity respectively will always add up to zero.

                        ∆A-∆L=∆E