FINANCIAL

ACCOUNTING 1
CUACM 105
INTRODUCTION
 GOLDEN RULE
Accounting CAN NOT be studied by merely reading/
memorizing. You need to practice, practice and
practice also.
 FINACIAL ACCOUNTING 1 (CUAC105)
WHAT IS ACCOUNTING?
Accounting is a process consisting of three activities, namely:
1. Identifying those events that are evidence of economic activity (transactions) relevant to the
particular business or entity.
2. Recording the monetary value of the economic event ( transactions) so as to provide a permanent
history of the financial activities of the business. Recording consists of keeping a chronological diary
of measured events in an orderly and systematic manner. Recording implies that economic events
are also classified and summarized.
3. The third activity encompasses the communication of the recorded information to the interest
users. The information is communicated through the preparation of and distribution of accounting
reports, the most common of which are known as financial statements.
 GOLDEN RULE
Accounting records transactions to provide useful
information for decision making
 USERS OF FINANCIAL INFORMATION
• Investors
• Trade payables
• Government
• Customers external users
• Suppliers
• Lenders
• Public

• Management
• Employees Internal users
 FIELDS OF ACCOUNTING
1. Financial accounting-this field is concerned with the recording of transactions and
the preparation of the financial statement regarding the entity as a whole. Financial
accounting is governed by General Accepted Accounting Practice (GAAP), which
consists of external standard that must be adhered to. The standards assure the
comparability of financial statement between enterprises.
2. Management accounting- this provides financial information for specific purposes.
Managers use this information in their decision making, which leads to the
attainment of the objectives of the enterprise. Without the financial information it
would be difficult for management to manage effectively.
 Financial accounting
• Financial accounting is concerned with the production of financial statements for
external users. These are a report on the directors’ stewardship of the funds
entrusted to them by the shareholders. Investors need to be able to choose which
companies to invest in and compare their investments. In order to facilitate
comparison, financial accounts are prepared using accepted accounting
conventions and standards. International Accounting Standards (IAS® Standards)
and International Financial Reporting Standards (IFRS® Standards) help to reduce
the differences in the way that companies draw up their financial statements in
different countries. The financial statements are public documents, and therefore
they will not reveal details about, for example, individual products’ profitability.
 Management accounting
Management require much more detailed and up-to-date information in order to control the
business and plan for the future. Management needs to be able to cost-out products and
production methods, assess profitability and so on. In order to facilitate this, management
accounts present information in any way which may be useful to management, for example
by operating unit or product line. Management accounting is an integral part of management
activity concerned with identifying, presenting and interpreting information used for:
• formulating strategy
• planning and controlling activities
• decision making
• optimising the use of resources.
 USERS OF FINANCIAL STATEMENTS
Investors
Investors and potential investors are interested in their potential profits and the
security of their investment. Future profits may be estimated from the target entity’s
past performance as shown in the statement of profit or loss. The security of their
investment will be revealed by the financial strength and solvency of the entity as
shown in the statement of financial position. The largest and most sophisticated
groups of investors are the institutional investors, such as pension funds and unit
trusts.
 USERS OF FINANCIAL STATEMENTS
Employees and trade union representatives need to know if an employer can offer
secure employment and possible pay rises. They will also have a keen interest in the
salaries and benefits enjoyed by senior management. Information about divisional
profitability will also be useful if a part of the business is threatened with closure.
Lenders need to know if they will be repaid. This will depend on the solvency of the
entity, which should be revealed by the statement of financial position. Long-term
loans may also be backed by ‘security’ given by the business over specific assets. The
value of these assets will be indicated in the statement of financial position.
 USERS OF FINANCIAL STATEMENTS
Government agencies need to know how the economy is performing in order to
plan financial and industrial policies. The tax authorities also use financial
statements as a basis for assessing the amount of tax payable by a business.
Suppliers need to know if they will be paid. New suppliers may also require
reassurance about the financial health of a business before agreeing to supply goods.
 USERS OF FINANCIAL STATEMENTS
Customers need to know that an entity can continue to supply them into the future. This
is especially true if the customer is dependent on an entity for specialised supplies.
The public may wish to assess the effect of the entity on the economy, local
environment and local community. Companies may contribute to their local economy
and community through providing employment and patronising local suppliers. Some
companies also run corporate responsibility programmes through which they support the
environment, economy and community by, for example supporting recycling schemes.
 Types of business entity
A business can be operated in one of several ways:
Sole trader
This is the simplest form of business where a business is owned and operated by one individual, although it might
employ any number of people. With this form of entity there is no legal distinction between the owner and the
business. To this end the owner receives all of the profits of the business but has unlimited liability for all the
losses and debts of the business.
The capital structure of a sole trader is also relatively simple. There is a capital account which represents the
financial interest of the owner in the business. The capital account can be added to by the owner introducing
additional capital into the business, or by the business making profits, which the sole trader is entitled to. The
capital account can be reduced by the sole trader making withdrawals from the capital account during the year
(often referred to a 'drawings') or by the business making losses.
 Types of business entity
Partnership
Similar to a sole trader the owners of a partnership receive all the profits and have unlimited
liability for the losses and debts of the business. The key distinction is that there are at least
two owners. The joint owners, or partners, are jointly and severally liable for the losses the
business makes (i.e. they are each fully liable in respect of all business liabilities). The
capital structure of a partnership is similar to that of a sole trader. Each partner will have a
financial interest in the business and this will be divided between a capital account and
current account. The capital account is normally a fixed amount that will only change upon a
partner joining or leaving the business. The current account includes the share of profit or
loss that each partner is entitled to, less any personal drawings made by that partner
 Types of business entity
Limited liability companies
Unlike sole traders and partnerships, limited liability companies are established as separate legal entities to their
owners. This is achieved through the process of incorporation. The owners of the company (the shareholders)
invest capital in the business in return for a shareholding that entitles them to a share of the residual assets of the
business (i.e. what is left when the company is wound up or liquidated). The shareholders are not personally
liable for the debts of the company and whilst they may lose their investment if the company becomes insolvent
they will not have to pay the outstanding debts of the company if such a circumstance arises. Likewise, the
company is not affected by the insolvency (or death) of individual shareholders. Limited liability companies are
managed by a board of directors who are elected by the shareholders.
The capital structure of a limited liability company is more formalised than that of a sole trader or partnership
and is illustrated within this chapter. Shareholders cannot make withdrawals or 'drawings' from the business
in the way that a sole trader or partner is able to do. Instead, they receive a return on their investment in the
company referred to as a dividend which is paid from accumulated profits.
 GOLDEN RULE
Financial statements must review a fair presentation of the
financial position, finance performance and cash flow of an
entity’