CHAPTER 1: Introduction To Accounting

 

FUNDAMENTALS OF ACCOUNTING

 What is accounting?

Accounting may be defined as the process of identifying, measuring, recording and communicating financial information in order to permit users to make informed decisions or judgment by the users of the financial information.

Accounting maybe referred by some authors as Book-keeping, which is the analysis, identification, measuring, classifying and recording of financial transactions in the books of accounts.

Accounting maybe viewed as the language used in business and forms a common media through which users of accounting information can effectively communicate business matters and understand each other equally in a business.

Accounting facilitates communication of the business records, transactions and summarizes results of business operations; forming the information of economic value to a business which forms the basis for judgment by the users. 

THE ACCOUNTING PROCESS

Since accounting is a process, it can be divided into four phases;

1.      Recording phase

This involves the routine and mechanical process of writing business transactions and events in the books of accounts (books of original entry) when they occur in a chronological order in accordance with the entity’s and other established accounting rules and procedures.

2.      Classifying phase

It involves sorting and grouping of similar transactions into their respective classes by posting them into a ledger which is defined as a book containing groups of accounts of a similar nature.

3.      Summarizing phase

This involves the preparation of financial statements or reports. It is usually done periodically e.g. monthly, annually etc.

Financial accounts include:

ü Trading account

ü Profit and loss account

ü Balance sheet etc.

 

4.      Interpretation 

This is the process of analyzing of the accounting information.  It involves communication of financial information to help users in making economic decisions.'

DIVISIONS OF ACCOUNTING

Accounting can be divided into the following categories of specialization;

i.                 Financial accounting

Financial accounting concerns itself with the collection and processing of accounting data and reporting to interested parties inside and outside the firm.

ii.             Cost accounting

Cost accounting helps establish costs relating to the production of a good or service and allocating it to the various factors that contributed to the cost of production.

iii.         Managerial accounting

Managerial accounting deals with the generation of accounting information to be used categorically by the firm’s internal management in their day-to-day decision making.

iv.           Tax accounting

Tax accounting deals with the determination of the firm’s tax liability which could be, Value added tax (VAT), customs duty, Pay as you earn (PAYE), corporation tax etc.

v.               Auditing

Auditing concerns itself with the vouching and verification of transactions from the financial accounting to determine that they are a true representation of the business’ activity i.e. the true and fair view of the company’s situation.

USERS OF FINANCIAL INFORMATION  

 a)  Management

Management of business run day to day operations of the business. They need accounting information to assist for planning, decision making and to prepare budgets and compare with the actual results of operations.

They are also interested in the profitability of the firm and see whether the business is running as per controls.

b   b) Employees

Employees provide labor for the firm in exchange of wages and salaries. They are interested about the stability and profitability of their employer. It is a source of stability for them and they need to know whether to start searching for employment elsewhere or keep their current postings. They are also concerned about the ability to provide remuneration, retirement benefits and employment opportunities.

c     c)  Owners or shareholders

They have invested capital for the operation of the business. They therefore would like to know whether the funds are properly used by the management or no and know the profitability and how financial resources of the business are. They also need the accounting information to assess whether to make additional capital or drawings.

     d) Present and potential investors

They need accounting information to assess the risk inherent in, and the return provided by their investments. They need information to decide whether they should maintain, increase, decrease of dispose altogether their investments.

       e) Creditors

They include suppliers of goods on credit, banks and other money lenders. They would want to know the financial position of the business before giving loans and goods on credit. They would want to ascertain that the business would not experience payment difficulties.

 f) Government – the government is interested in this information that will enable establishment of earning and sales for a time.

 g) Consumers – they need the information in order to establish existence of good accounting controls within the organization. This will enable them to establish effective cost of production and therefore determine the change in prices of goods.

h) Financial analysts – they need to study financial operations for a firm in order to analyze accounts.

 IMPORTANCE OF ACCOUNTING 

i.                  Helps in decision making concerning acquisition, use and preservation of scarce resources.

ii.               Acts as a tool of control since it helps to control the business such that unnecessary expenses, misappropriation of funds and assets are avoided.

iii.           Ascertain profit and loss to establish whether the business is making profits or losses.

iv.            Assessment of tax. Business usually pays tax based on profits made, which can be ascertained from the accounting information.

v.              Facilitates credit transactions. Accounting provides information on the amounts due to creditors and amounts due to debtors.

vi.           Helps in recording changes to the value of assets and liabilities

vii.       Helps in devising remedies for deviation of actual performance from planned performance.

viii. Helps to communicate results of a business to the users.

LIMITATIONS OF ACCOUNTING INFORMATION

1.   Accounting information is prepared based from past period monetary transactions. It is hardly feasible that what happened in the past will hold on in the future and so the accounting information may be considered irrelevant on that basis alone.

2.   Accounting information consists of too  many  figures  and  less  of  explanations.  For any system to be useful, it must strike a balance between quantitative and qualitative measures.

3.   Accounting information makes it only comparable to businesses of similar nature. It is difficult to compare a service-oriented organization to a manufacturing-based firm.

4.   Accounting may not be realistic due to its difficult concepts and conceptions.

5.    Personal biasness of the accountant may affect the financial statements.

 

QUALITIES OF GOOD ACCOUNTING INFORMATION

1.   Understandability

For accounting information to be considered useful, it must be well understood by the parties for which it was prepared for. The parties must be able to derive satisfaction from the financial data represented by accounting.

2.   Relevance

The accounting information should be able to influence the important decisions in the company. The information should be verifiable, neutral and truthful.

3.   Reliability

Reliability means that the accounting information should have differing methods or ways of doing it and yet arrive at the same or similar conclusions.

4.   Comparability

The accounting information should be able to be compared with other information from different organizations or of the same organization at differing periods.

5.   Timely

 If the accounting information is not availed to the deserving user at the time of need, then it may as well be useless. For accounting information to be useful, it must be presented to the party in need at the time of the need.