1. | FUNDAMENTALS OF ACCOUNTING I Introduction to Accounting

2. | Chapter Objectives i.objective of accounting ii.Identify and explain the characteristics of financial information iii.Understand and explain the fundamental assumptions and concepts of accounting iv.Understand the accounting equation and define capital, assets and liabilities. v.Appreciate the uses and limitations of accounting

3. | Introduction 1.1 The Nature and Purpose of Accounting The purpose of accounting is to maintain proper control of finances of an entity which is achieved by: i.Accurate recording of data ii.Classifying the summarized data iii.Analysing and interpreting the classified data iv.Communicating what has been learnt to interested parties

4. | Objectives of accounting The main objective is to provide information about the financial position, performance and financial adaptability of an enterprise. This information is used by a variety of users. Financial reporting should provide information that is useful to present and potential investors and creditors and other users. Financial reporting should provide information about how the management of an enterprise has discharged its stewardship responsibility to owners (the use of enterprise resources entrusted to management).

5. | Other Objectives Internal Control: Including the safeguarding of organization's 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 and dishonesty by the employees of the organization. Measurement of financial data: By means of recording of transactions and events affecting the financial state of the organization and their processing in accordance with consistent rules. Financial reporting: reporting of financial information to proprietors, investors and other interested persons, by presentation of annual or more frequent financial statements.

6. | What is accounting? Accounting is the process of collecting, recording, summarizing, interpreting and communicating financial information to permit informed decisions. It involves the art of recording, classifying and summarizing of transactions and events and the interpretation of results thereafter. Any organization requires written records which are used by management on a day to day basis to make decisions and set up procedures on how to relate with individuals and other organizations.

7. | What is book keeping? This is a methodical (in a prescribed manner) or systematic (according to set rules) recording of business’ day to day (routine) transactions in monetary terms so that information with regards to the profitability and the financial position of the business may be readily ascertained by interested parties. What are accounts? These are records in which financial information is contained.

8. | Users of accounting information A business should produce information about its activities in the form of records and reports. This information is provided to various interested external parties (users). Sound financial information forms the basis of appropriate decision making. These users can e categorized into two groups namely; – Internal users – External users

9. | Internal users Owners of the business and the management. Accounting information helps owners in the decision making process e.g. the launch of new products, the payment of employees’ salaries e.t.c. Employees: employees would want to know the results of the company so as to 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.

10. | External Users These include: Tax and regulatory authorities (government): the government is interested in the business performance in order to assess the tax payable. The government is also interested in whether the business is carrying out its operations all relevant laws. Investors: The shareholders (investors) wish to know how efficiently management is performing its steward function and how profitable the business is. They are also concerned about sustainability of the business venture.

11. | External Users contd…. Debt Providers (Lenders): They are interested in the solvency of the firm, ability to keep up with interest payments and eventually the repayment of the principal amount borrowed by the business. They are also interested in things like the compliance with any loan agreements and other risks. Creditors/ suppliers: These advance credit on a short term basis to the business. They use financial information to determine whether the business can generate enough return to be able to pay them. Competitors: They use financial information to determine the performance of the firms in order to remain competitive in the market.

12. | External Users contd…. Customers: Customers need to be assured that the business is a steady source of supply such that the goods they require can be delivered when needed. In addition customers are increasingly sensitive to the quality of products and therefore, due care should be taken in the production.

13. | External Users contd…. General Public: A business is a member of the local community, customers, employees or shareholders. Every enterprise relates to the general public. The public is concerned mainly with whether the business is socially responsible both in terms of social norms and sustainability.

14. | Qualitative Characteristics of accounting information distinguish better (more useful) information from inferior (less useful) information for decision-making purposes.” Qualitative Characteristics

15. |

16. | Fundamental Quality—Relevance To be relevant, accounting information must be capable of making a difference in a decision.

17. | Qualitative Characteristics Fundamental Quality—Relevance Financial information has predictive value if it has value as an input to predictive processes used by investors to form their own expectations about the future.

18. | Qualitative Characteristics Fundamental Quality—Relevance Relevant information also helps users confirm or correct prior expectations.

19. | Second Level: Qualitative Characteristics Fundamental Quality—Relevance Information is material if omitting it or misstating it could influence decisions that users make on the basis of the reported financial information.

20. | Qualitative Characteristics Fundamental Quality—Faithful Representation Faithful representation means that the numbers and descriptions match what really existed or happened.

21. | Qualitative Characteristics Fundamental Quality—Faithful Representation Completeness means that all the information that is necessary for faithful representation is provided.

22. | Qualitative Characteristics Fundamental Quality—Faithful Representation Neutrality means that a company cannot select information to favor one set of interested parties over another.

23. | Qualitative Characteristics Fundamental Quality—Faithful Representation An information item that is free from error will be a more accurate (faithful) representation of a financial item.

24. | Qualitative Characteristics Enhancing Qualities Information that is measured and reported in a similar manner for different companies is considered comparable.

25. | Qualitative Characteristics Enhancing Qualities Verifiability occurs when independent measurers, using the same methods, obtain similar results.

26. | Qualitative Characteristics Enhancing Qualities Timeliness means having information available to decision- makers before it loses its capacity to influence decisions.

27. | Qualitative Characteristics Enhancing Qualities Understandability is the quality of information that lets reasonably informed users see its significance.

28. | Accounting Concepts and Principles Accounting is called the language of business that which communicates the financial condition of a business to interested users. In order to become effective in carrying out the accounting and communicating the financial information of the business, there is a set of rules, concepts and principles that governs the application of the accounting procedures. 28

29. | 29 Accounting Concepts Business entity Money Measurement/stable monetary unit Going Concern Historical Cost Prudence/conservatism Materiality

30. | 30 Objectivity Consistency Accruals/matching Uniformity Disclosure Relevance

31. | 31 Business Entity Meaning – The business and its owner(s) are two separate existence entity – Any private and personal incomes and expenses of the owner(s) should not be treated as the incomes and expenses of the business.

32. | 32 Examples – Insurance premiums for the owner’s house should be excluded from the expense of the business – The owner’s property should not be included in the premises account of the business – Any payments for the owner’s personal expenses by the business will be treated as drawings and reduced the owner’s capital contribution in the business

33. | 33 Money Measurement Meaning – All transactions of the business are recorded in terms of money – It provides a common unit of measurement Examples – Market conditions, technological changes and the efficiency of management would not be disclosed in the accounts

34. | 34 Going Concern Meaning – The business will continue in operational existence for the foreseeable future – Financial statements should be prepared on a going concern basis unless management either intends to liquidate the enterprise or to cease trading, or has no realistic alternative but to do so

35. | 35 Example – Possible losses form the closure of business will not be anticipated in the accounts – Prepayments, depreciation provisions may be carried forward in the expectation of proper matching against the revenues of future periods

36. | 36 Historical Cost Meaning – Assets should be shown on the balance sheet at the cost of purchase instead of current value Example – The cost of fixed assets is recorded at the date of acquisition cost. The acquisition cost includes all expenditure made to prepare the asset for its intended use. It included the invoice price of the assets, freight charges, insurance or installation costs

37. | 37 Prudence/Conservatism Meaning – Revenues and profits are not anticipated. Only realized profits with reasonable certainty are recognized in the profit and loss account – However, provision is made for all known expenses and losses whether the amount is known for certain or just an estimation – This treatment minimizes the reported profits and the valuation of assets

38. | 38 Example – Stock valuation sticks to rule of the lower of cost and net realizable value – The provision for doubtful debts should be made – Fixed assets must be depreciated over their useful economic lives

39. | 39 Materiality Meaning – Immaterial amounts may be aggregated with the amounts of a similar nature or function and need not be presented separately – Materiality depends on the size and nature of the item

40. | 40 Objectivity Meaning – The accounting information should be free from bias and capable of independent verification – The information should be based upon verifiable evidence such as invoices or contracts

41. | 41 Consistency Meaning – Companies should choose the most suitable accounting methods and treatments, and consistently apply them in every period – Changes are permitted only when the new method is considered better and can reflect the true and fair view of the financial position of the company – The change and its effect on profits should be disclosed in the financial statements

42. | 42 Accruals/Matching Meaning – Revenues are recognized when they are earned, but not when cash is received – Expenses are recognized as they are incurred, but not when cash is paid – The net income for the period is determined by subtracting expenses incurred from revenues earned

43. | 43 Example – Expenses incurred but not yet paid in current period should be treated as accrual/accrued expenses under current liabilities – Expenses incurred in the following period but paid for in advance should be treated as prepayment expenses under current asset – Depreciation should be charged as part of the cost of a fixed asset consumed during the period of use

44. | 44 Disclosure Meaning – Financial statements should be prepared to reflect a true and fair view of the financial position and performance of the enterprise – All material and relevant information must be disclosed in the financial statements

45. | 45 Uniformity Meaning – Different companies within the same industry should adopt the same accounting methods and treatments for like transactions – The practice enables inter-company comparisons of their financial positions

46. | 46 Relevance Meaning – Financial statements should be prepared to meet the objectives of the users – Relevant information which can satisfy the needs of most users is selected and recorded in the financial statement

47. | The Accounting Equation Assets=capital +Liabilities All firms have resources known as Assets. The resources/assets supplied by the owner are known as Capital Capital-Owner supplied funds. Other assets that are non-owner supplied funds are known as Liabilities 6/28/2016MIS Notes 47

48. | Capital = Assets-liabilities Capital = Net Assets Liabilities = Assets-capital Assets A resources that the business owns or has control of; as a result of past events from which economic cash flows/economic benefits are expected to flow to the firm. The most common past event being purchase of the asset. 6/28/2016MIS Notes 48

49. | There are 2 classes of assets – Non-current assets/fixed assets – Current assets Non-Current Assets An asset acquired for continuing use within the business with an aim of earning income or making profits from its use, not acquired for re-sale to a customer. Non-current assets can either be tangible or intangible. 6/28/2016MIS Notes 49

50. | Tangible assets have physical existence e.g. Land and buildings, Plant and machinery, Fixtures, furniture and fittings and Motor vehicles Intangible assets have no physical existence.e.g. patents, copyrights, goodwill. 6/28/2016MIS Notes 50

51. | Current Assets Resources/assets owned by the business with an intention of turning them into cash in a short time (one year usually) That is, they form part of the business’ operating cycle or they are held for trading purposes. 6/28/2016MIS Notes 51

52. | Stocks/inventories-goods for sale Debtors/trade accounts receivables, which are amounts owing from customers Other debtors’ e.g. accrued income such as rent. Prepayments e.g. rent Cash at bank Cash in hand. 6/28/2016MIS Notes 52

53. | Liabilities Is an obligation of the firm as a result of past events, settlement of which is expected to result to an economic cash flow from the firm. The 2 classes of liabilities are; Current liabilities Non-current liabilities. 6/28/2016MIS Notes 53

54. | Current Liabilities Debts payable or due within one year e.g.Loans payable within one year Bank overdraft, which are usually repayable on demand Trade accounts payable /creditors for goods Other creditors e.g. rent Taxation payable Accruals e.g. rent and electricity. 6/28/2016MIS Notes 54

55. | Non-current liabilities Not payable within the short term. Therefore they are expected to last for a period of more than one year. e.g.Loans Loan stocks- security issued by limited liability companies at a fixed rate of interest.The security holders are lenders of money to the business. 6/28/2016MIS Notes 55

56. | Capital Called the owners equity; the owners interest in the firm after deducting the liabilities from the assets. In case of a sole trader, capital comprises of funds invested in the firm by the owner plus any retained profits. Retained profits mean profits not paid out to the owner in terms of drawings. 6/28/2016MIS Notes 56

57. | Balancing of the accounting equation will always happen despite any changes in assets, liability or capital amounts since every entry in any account has a dual/double effect in the accounts. 6/28/2016MIS Notes 57

58. | Ole Sangale Road, Madaraka Estate. PO Box 59857-00200, Nairobi, Kenya Tel +254 (0)20 606155, 606268, 606380 Fax +254 (0)20 607498 Mobile +254 (0)722 25 428, (0)733 618 135 Email info@strathmore.edu www.strathmore.edu