Chapter 1: Introduction to Accounting
1.1 Definition of Accounting
Accounting is the process of:
Recording: Keeping track of financial transactions.
Classifying: Sorting transactions into categories (e.g., revenue, expenses).
Summarizing: Bringing all transaction information together.
Interpreting: Analyzing financial data to make informed decisions.
1.2 The Purpose of Accounting
Accounting helps businesses manage their financial information by:
Providing financial information to stakeholders like owners, investors, creditors,
and government agencies.
Helping with decision-making by offering insights into profitability, liquidity, and
solvency.
Ensuring accountability and transparency in financial reporting.
1.3 Users of Accounting Information
Internal Users: People within the organization who use accounting information for
decision-making.
o Management: Make decisions about operations, budgeting, and planning.
o Employees: May use financial data for salary negotiations, job security, etc.
External Users: People or groups outside the organization who rely on financial
reports.
o Investors: Evaluate the company’s performance and decide whether to buy or sell
stock.
o Creditors: Banks or suppliers who evaluate whether to lend money or extend
credit.
o Government: Uses accounting information for taxation, regulatory compliance,
etc.
1.4 The Accounting Equation
The foundation of double entry bookkeeping:
Assets=Liabilities+Owner’s Equity
Assets: What the business owns (e.g., cash, inventory, buildings).
Liabilities: What the business owes (e.g., loans, accounts payable).
Owner’s Equity: The owner’s stake in the business represented by their
investment plus retained earnings.
1.5 Double-Entry Bookkeeping
The basis of modern accounting, which ensures that every transaction affects at
least two accounts. For example:
If the business buys equipment for cash, Cash decreases (credit) and Equipment
increases (debit).
In double entry:
Debits (Dr): Increase assets and expenses, decrease liabilities and income.
Credits (Cr): Decrease assets and expenses, increase liabilities and income.
This system helps maintain balance in the accounting equation.
1.6 The Role of an Accountant
Accountants are responsible for:
Recording transactions in journals and ledgers.
Preparing financial statements, such as the balance sheet and income
statement.
Advising management on financial matters and ensuring compliance with laws
and regulations.
Ensuring the accuracy of financial reports and providing assurance to
stakeholders that the accounts are correct.
1.7 Types of Accounts
In accounting, there are three main types of accounts:
1. Personal Accounts: Related to individuals or businesses (e.g., accounts payable,
accounts receivable).
2. Real Accounts: Concerned with assets (e.g., cash, machinery, land).
3. Nominal Accounts: Concerned with income, expenses, gains, and losses (e.g.,
sales revenue, wages, rent).
1.8 The Accounting Cycle
The process that accountants follow to record financial transactions:
1. Recording: Transactions are recorded in journals.
2. Posting: Information is transferred to the ledger.
3. Trial Balance: A summary of all ledger balances to ensure the accounts are
balanced (debits = credits).
4. Preparing Financial Statements: The income statement and balance sheet are
created based on the trial balance.
5. Closing Accounts: Temporary accounts (like revenues and expenses) are closed
to prepare for the next accounting period.
1.9 Basic Accounting Terms
Capital: The investment made by the owner(s) in the business.
Revenue: Income earned from selling goods or services.
Expense: Costs incurred in running the business, like rent, wages, or utilities.
Profit: The excess of revenue over expenses.
o Net Profit: The final profit after all expenses are deducted from revenues.
Loss: When expenses exceed revenue.
