Chapter 1: Introduction to Accounting
Definition of Accounting
Accounting is the systematic and comprehensive process of identifying, measuring, recording, classifying, summarizing,
and interpreting financial information. Its primary objective is to provide useful data for decision-making by both internal
and external users.
Purpose of Accounting
The purpose of accounting is to provide information that is:
Useful to users in making economic decisions
Helpful in assessing past performance and predicting future outcomes
Necessary for compliance with legal and regulatory requirements
Users of Accounting Information
Internal Users: Managers, officers, employees – people who use the information for planning, controlling, and
decision-making within the business.
External Users: Investors, creditors, government agencies, customers, suppliers, and the public – they use
financial statements to assess the financial position and performance of the business.
Branches of Accounting
Financial Accounting – focuses on reporting financial information to external users.
Managerial Accounting – deals with internal decision-making processes.
Cost Accounting – analyzes the cost structure of a business.
Tax Accounting – concerned with preparing tax returns and tax planning.
Auditing – independent examination of financial records.
Government Accounting – used in public sector organizations.
Accountable vs Non-Accountable Events
Accountable Events: Transactions that affect the financial position of the business and can be measured in
monetary terms (e.g., sale of goods, payment of expenses).
Non-Accountable Events: Events that cannot be measured financially or do not affect the accounting records
(e.g., hiring of an employee).
Historical Development of Accounting
Originated in ancient Mesopotamia (~8500 BC)
Double-entry system introduced in 1340 AD and popularized by Luca Pacioli in 1494
Chapter 2: Accounting Concepts and Principles
Accounting Concepts (Basic assumptions that form the foundation of accounting)
Economic Entity: The business is treated as separate from its owners and other businesses.
Going Concern: The business is expected to continue operations for the foreseeable future.
Monetary Unit: Only transactions measurable in monetary terms are recorded.
Accrual Basis: Transactions are recorded when they occur, not when cash is received or paid.
Accounting Principles (Guidelines used in preparing financial statements)
Historical Cost: Assets are recorded based on their original cost.
Revenue Recognition: Revenue is recognized when earned, regardless of when cash is received.
Matching Principle: Expenses are matched with the revenues they help generate in the same period.
Full Disclosure: All relevant information should be included in financial reports.
Consistency: The same accounting methods should be applied consistently over time.
Conservatism (Prudence): In case of uncertainty, choose the option that will not overstate assets or income.
Materiality: All significant items should be reported if they affect decision-making.
Recognition Criteria for Elements of Financial Statements
Probable economic benefit
Measurable with reliability
Constraint in Financial Reporting
Cost Constraint: The benefits of financial information should outweigh its preparation costs.
Chapter 3: The Accounting Equation and Financial Statements
The Basic Accounting Equation
Assets = Liabilities + Owner’s Equity
This equation must always remain balanced. Assets are the resources owned, liabilities are obligations, and equity is the
owner’s interest.
Expanded Accounting Equation
Assets = Liabilities + Capital + Revenues – Expenses – Drawings
This includes the effects of the business's operations and the owner’s withdrawals.
Double-Entry System
Each transaction has at least two effects on the accounting equation. This is the foundation of double-entry bookkeeping,
where every debit has a corresponding credit.
Rules of Debit and Credit
Assets – Increase with Debit, Decrease with Credit
Liabilities – Increase with Credit, Decrease with Debit
Equity – Increase with Credit, Decrease with Debit
Revenue – Increase with Credit, Decrease with Debit
Expenses – Increase with Debit, Decrease with Credit
Types of Financial Statements
1. Statement of Financial Position (Balance Sheet): Shows assets, liabilities, and equity at a point in time.
2. Income Statement: Reports revenues and expenses, resulting in net income or loss.
3. Statement of Changes in Equity: Summarizes changes in owner’s equity (e.g., investments, drawings, net
income).
4. Statement of Cash Flows: Shows cash inflows and outflows from operating, investing, and financing activities.
Chapter 4: Types of Major Accounts
Definition of an Account
An account is a record that summarizes all transactions related to a particular item (e.g., Cash, Accounts Payable, Sales
Revenue).
Classification of Accounts
1. Assets: Economic resources owned (e.g., cash, equipment)
2. Liabilities: Debts or obligations (e.g., loans, accounts payable)
3. Owner’s Equity: Owner’s claim on assets (capital, retained earnings)
4. Income: Increases in equity due to business operations (sales, interest income)
5. Expenses: Decreases in equity from using resources (utilities, rent, salaries)
Types of Accounts by Nature
Real Accounts (Permanent): Asset, liability, and capital accounts that carry balances forward to the next period.
Nominal Accounts (Temporary): Revenue, expense, and drawing accounts that are closed at the end of the
accounting period.
Chapter 5: Books of Accounts and the Double-Entry System
Books of Accounts
o Journal (Book of Original Entry): Transactions are first recorded here in chronological order.
o General Journal: For entries that don’t fit special journals.
o Special Journals: Sales journal, purchases journal, cash receipts journal, cash disbursements journal.
o Ledger (Book of Final Entry): Where transactions are classified and posted to specific accounts.
o General Ledger: Contains all accounts.
o Subsidiary Ledger: Provides detail for control accounts (e.g., accounts receivable ledger).
Steps in the Recording Process
1. Identify the transaction/event
2. Analyze which accounts are affected and whether they increase or decrease
3. Journalize the entry
4. Post the entry to the ledger
5. Prepare a trial balance
6. Adjust entries as needed
7. Prepare financial statements
8. Close nominal accounts
9. Prepare post-closing trial balance
Double-Entry System Concepts
Dual Aspect: Each transaction has two sides – a giving and receiving.
Balance: Total debits must equal total credits to maintain the integrity of the accounting equation.
