Acfn 1031 Chapter One Introduction To Accounting & Business

SEEK WISDOM, ELEVATE YOUR EXCELLENCE & SERVE HUMANITY
AcFn 1031
Chapter One
Introduction to Accounting & Business
AAU School of Commerce Acfn 1031

October 2017 1
Ch1: Introduction to Accounting and
Business
Outline
– The nature of a business
– Types of business organizations in Ethiopia
– The role of accounting in business
– The profession of Accounting
– Overview of International Financial Reporting Standards
(IFRS)
– Overview of Financial Reporting Requirements in
Ethiopia and AABE
– The accounting equation and elements of the equation
– Business transactions and financial statements
Fundamentals of Accounting I-AAUSC,
AAUSC, 2017
..Ch1: Introduction to Accounting and
Business
Chapter Objectives
After studying this chapter, you should be able to:
1. Explain what accounting is.
2. Identify the users and uses of accounting.
3. Understand why ethics is a fundamental business concept.
4. Explain accounting standards and the measurement principles.
5. Explain the monetary unit assumption and the economic
entity assumption.
6. State the accounting equation, and define its components.
7. Analyze the effects of business transactions on the
accounting equation.
8 Understand the four financial statements and how they
are prepared.
AAUSC, 2017
Business
The Nature of Business
 A business is an organization in which basic
resources (inputs), such as materials and labor,
are assembled and processed to provide goods
or services (outputs) to customers.
 Businesses come in several types and sizes,
(Small shops, Supermarkets, Laundry, Hotels,
Garage, educational institutions, banks,
insurance and so on)

AAUSC, 2017
Business
Activity:
Write 5 business activities/organizations that
you know.

AAUSC, 2017
…Ch1: Introduction to Accounting and
Business
…The Nature of Business
Organizations can be classified in various forms:
 Based on objective:
 Profit making/ Not for Profit organizations
 Based on Function:
 Service giving, Merchandising, Manufacturing, Farming ..
 Based on Ownership, there are three common forms of
businesses:
 Sole Proprietorship,
 Partnership
 Corporation (Share Company)
 Private Limited Company (PLC)
AAUSC, 2017
…Ch1: Introduction to Accounting and Business
Forms of Business Ownership
Proprietorship Partnership Corporation
 Generally owned
by one person
 Owned by two or  Ownership
more persons divided into
 Often small shares
service-type  Often retail and
businesses service-type  Separate legal
businesses entity organized
 Owner receives under corporation
any profits,  Generally
unlimited law
suffers any
losses, and is personal liability  Limited liability
personally liable  Partnership
for all debts agreement
LO 5I-AAUSC,
Fundamentals of Accounting Explain the monetary unit assumption
AAUSC, 2017 and the economic entity assumption.
Business
…The Nature of Business
Regardless of the objective, size, function and
form of ownership, all organizations are
required to keep records showing their
financial activities. This implies the fact that
accounting is needed in all types of
organizations.
 So what is Accounting? Why it is needed in all
organizations?

AAUSC, 2017
Business
Activity: (Homework)
1. Write forms of business organizations as
stated in Commercial code of Ethiopia
1960.
2.List and briefly describe 10 organized
business activities in your sub city in light
of the commercial code.

AAUSC, 2017
What is Accounting?
Accounting consists of three basic activities - it

 identifies,
 records, and
 communicates
the economic events of an organization to interested users.

AAUSC, 2017 LO 1 Explain what accounting is.
What is Accounting? Illustration 1-1
Three Activities The activities of the

accounting process
The accounting process includes

the bookkeeping function.

AAUSC, 2017 LO 1 Explain what accounting is.
Difference between Bookkeeping & Accounting
Book Keeping Accounting
 It is the recording part of •It is wider than book-keeping.
accounting •It includes activities such as
 It is purely clerical in designing the system of book
nature keeping (recording), it includes
 It is performed by Book- preparation and interpretation of
keepers or account clerks financial reports.
•It is performed by Accountants
•Accountants are more qualified
than book keepers, they review
the work of book keepers
AAUSC, 2017
Business
……What is Accounting?
Accounting is the language of business – it
can be viewed as an information system that
identifies, measures, and communicates
financial information about economic entities
to interested persons.
Accounting mainly deals with information
that is quantitative in nature.

AAUSC, 2017
Business
 The Nature of Accounting can be summarized as
follows:
 Accounting is
 a service activity
 a descriptive/analytical discipline
 an information system
Accounting as a service activity:
 As a service activity, it provides interested parties
(users) with quantitative financial information that
helps them to make various decisions

AAUSC, 2017
Accounting as a descriptive/analytical
discipline:
It identifies mass of events and transactions that
characterize economic activity (purchases, sales,
collections, payments etc).
Through measurement, classification, and
summarization, it reduces those data to relatively
few, highly significant, and interrelated financial
reports.

AAUSC, 2017
Business
Accounting as an information system
It is a system with 3 parts Input-Processing-Output:
 It collects raw data as an input (invoices, receipts), then
 It processes the input (recording, classifying,
summarizing)
 Finally provides output in the form of financial
statements and communicates economic information
about business enterprise or other entity to a wide
variety of users to assist them in making decisions .
•


AAUSC, 2017
……Ch1: Introduction to Accounting and
Business
What is the Role of Accounting in

Business?
The Role of Accounting in business is to

provide financial information to
managers for use in operating the
business. In addition, accounting provides
information to other users in assessing the
economic performance and condition of
the business.

AAUSC, 2017
Business
Who are users of Accounting
Information?
Users of accounting information
are parties that are interested to
know about the financial activities
of the organization to make
various decisions

AAUSC, 2017
Business
 Users of accounting information can be broadly
classified into two categories;
Users of Accounting
Information
Internal Users External Users

AAUSC, 2017
Who Uses Accounting Data

External
Users
Internal
Users Human Taxing
Resources Authorities
Labor
Unions
Finance
Management Customers
Creditors
Marketing Regulatory
Agencies
Investors

LO 22017
AAUSC, Identify the users and uses of accounting.
Who Uses Accounting Data

Common Questions Asked User
1. Can we afford to give our
employees a pay raise? Human Resources
2. Did the company earn a
satisfactory income? Investors
3. Should any product lines be
eliminated? Management
4. Is cash sufficient to pay dividends
to shareholders? Finance
5. What price for our product will
maximize net income? Marketing
6. Will the company be able to pay
its debts? Creditors
LO 22017
AAUSC, Identify the users and uses of accounting.
Business
…….Internal users:
- Include Top executives, management, and
administrators within organizations. ( Managers at
different levels)
– Purpose: They need financial information to plan and
control operations
– Type of report & frequency- They need detailed and
frequent information
– These group of users have access to company
information

AAUSC, 2017
2. External Users
• Include Shareholders, Banks, Creditors, Investors,
suppliers, government
• Purpose: They need financial information about
entire company’s financial performance (Profit/loss),
financial position (resources and sources) and cash
flow
• Type of report: periodic report showing
aggregate/company wide information in the form of
general purpose financial statements
• They do not have access to company information
AAUSC, 2017
QUESTIONS ASKED BY EXTERNAL USERS

AAUSC, 2017
Business
• Fundamental relationships in the decision-
making process:
Accountant’s
analysis & Financial
Event Users
recording Statements

AAUSC, 2017
Business
How Accounting Evolves to its Current Stage?
Evolution of Accounting
• Similar to other fields of study, Accounting has
evolved to meet the increasing needs of the society
• As organizations increase in type, size and
complexities, the demand for financial information
has also increased
• Accounting has developed new concepts and
principles to meet these demands
AAUSC, 2017
Business
….Evolution of Accounting
• Primitive Accounting
– The oldest accounting record was the one that was found
in Babylonia in around 3600 B.C.
– Primitive accounting deals with limited aspect of
transactions
– There was no systematic recording
• Modern Accounting
– Modern accounting for business was developed in
response to the needs of Italian commercial orgs.
AAUSC, 2017
Business
…Evolution of Accounting
• Modern accounting was started with the
invention of a system of recording
known as “Double Entry Accounting
System”, a complete recording system
• This system was invented in 1494 in
Italy by an Italian Monk and
mathematician named Pacioli.
AAUSC, 2017
• Double Entry system provides a set of integrated reports
showing
1. The profit or loss (operation result) of a given
business for a certain period (Income statement)
2. The resources/assets/properties of a given business and the
sources of the finance to acquire these resources. (Statement
of Financial Position/Balance sheet)
• The invention of double entry accounting system is
considered to be the most important stage in the development
of accounting. In spite of the tremendous development in the
profession since 1494, the basic elements of the double entry
remains unchanged and it continues to this date.
AAUSC, 2017
Business
Influential factors for the Development of
Accounting
• The Industrial Revolution;
• The formation of Corporate forms of
organizations;
• The development of Public Accounting;
• The Government influence through tax
regulation and others.
AAUSC, 2017
The ACCOUNTING Profession/CAREER OPPORTUNITIES
Public Accounting Private Accounting

Careers in auditing, taxation, Careers in industry working in
and management consulting cost accounting, budgeting,
serving the general public. accounting information
systems, and taxation.
Government Forensic Accounting

Careers with the tax Uses accounting, auditing, and
authorities, law enforcement investigative skills to conduct
agencies, and corporate investigations into theft and
regulators. fraud.

LOAAUSC,
9 Explain2017 the career opportunities in accounting.
STUDY OBJECTIVES 3, 4 & 5
The Building Blocks of Accounting
The following are considered to be the building

blocks of accounting
1. Ethics
2. Accounting Standards (IFRS)
3. Measurement Principles & Assumptions

AAUSC, 2017
..The Building Blocks of Accounting
1. Ethics In Financial Reporting
Standards of conduct by which one’s actions are judged as
right or wrong, honest or dishonest, fair or not fair, are
ethics.
 Recent financial scandals include: Enron (USA),
Parmalat (ITA), Satyam Computer Services (IND), AIG
(USA), and others.
 Effective financial reporting depends on sound ethical
behavior.

LO 3 Understand why2017
AAUSC, ethics is a fundamental business concept.
The accounting equation and elements of the equation

The Accounting Equation: The foundation of accounting system.
The accounting (balance sheet) equation is an equation that expresses the
following relationships:
Assets = Liabilities + Owner’s Equity
=
Resources Sources of the resources
Equity = Creditors equity + Owners equity

AAUSC, 2017
The Basic Accounting Equation
Assets
Assets = Liabilities
Liabilities + Equity
Equity
Provides the underlying framework for recording and summarizing

economic events.
Applies to all economic entities regardless of size.
LO 6 State the accounting equation, and define its components.

Assets
Equity

economic events.
Assets
 Resources a business owns.
 Provide future services or benefits.
 Cash, Inventory, Equipment, etc.
Assets
Equity

economic events.
Liabilities
 Claims against assets (debts and obligations).
 Creditors - party to whom money is owed.
 Accounts payable, Notes payable, etc.

Assets
Equity

economic events.
Equity
Ownership claim on total assets.
Referred to as residual equity.
Share capital-ordinary and retained earnings.

Illustration 1-7
Revenues result from business activities entered into for the purpose
of earning income.
Generally results from selling merchandise, performing services,
renting property, and lending money.

Illustration 1-7
Expenses are the cost of assets consumed or services used in the

process of earning revenue.
Common expenses are salaries expense, rent expense, interest
expense, property tax expense, etc.

Illustration 1-7
Dividends are the distribution of cash or other assets to shareholders.

 Reduce retained earnings
 Not an expense

Classify the following items as issuance of shares, dividends,
revenues, or expenses. Then indicate whether each item
increases or decreases equity.
Classification Effect on Equity
1. Rent expense Expense Decrease
2. Service revenue Revenue Increase
3. Dividends Equity Decrease

4. Salaries expense Expense Decrease

Using the Accounting Equation
Transactions are a business’s economic events

recorded by accountants.
 May be external or internal.
 Not all activities represent transactions.
 Each transaction has a dual effect on the

accounting equation.
Illustration: Are the following events recorded in the

accounting records?
Illustration 1-8
Discuss
Purchase product
Event Pay rent.
computer. design with
customer.
Criterion Is the financial position (assets, liabilities, or equity)

of the company changed?
Record/ Don’t
Record
Transaction Analysis
Transaction (1). Investment by Shareholders. Ray and Barbara Neal
decides to open a computer programming service which he names
Softbyte. On September 1, 2014, they invest €15,000 cash in exchange for
€15,000 of ordinary shares. Illustration 1-10
LO 7
Transaction (2). Purchase of Equipment for Cash. Softbyte purchases
computer equipment for €7,000 cash.
Illustration 1-10
LO 7
Transaction (3). Purchase of Supplies on Credit. Softbyte purchases for
€1,600 from Acme Supply Company computer paper and other supplies
expected to last several months. The purchase is on account.
Illustration 1-10
LO 7
Transaction (4). Services Provided for Cash. Softbyte receives €1,200
cash from customers for programming services it has provided.
Illustration 1-10
LO 7
Transaction (5). Purchase of Advertising on Credit. Softbyte receives a
bill for €250 from the Daily News for advertising but postpones payment
until a later date.
Illustration 1-10
LO 7
Transaction (6). Services Provided for Cash and Credit. Softbyte
provides €3,500 of programming services for customers. The company
receives cash of €1,500 from customers, and it bills the balance of €2,000
on account.
Illustration 1-10
LO 7
Transaction (7). Payment of Expenses. Softbyte pays the following
expenses in cash for September: store rent €600, salaries and wages of
employees €900, and utilities €200.
Illustration 1-10
LO 7
Transaction (8). Payment of Accounts Payable. Softbyte pays its €250
Daily News bill in cash.
Illustration 1-10
LO 7
Transaction (9). Receipt of Cash on Account. Softbyte receives €600 in
cash from customers who had been billed for services [in Transaction (6)].
Illustration 1-10
LO 7
Transaction (10). Dividends. The corporation pays a dividend of €1,300 in
cash.
Illustration 1-10
LO 7
Financial Statements
Companies prepare four financial statements :
Retained Statement of
Income Statement of
Earnings Financial
Statement Cash Flows
Statement Position
LO 8 Understand the four financial statements and how they are prepared.
Question
Net income will result during a time period when:
a. assets exceed liabilities.
b. assets exceed revenues.
c. expenses exceed revenues.
d. revenues exceed expenses.
Net income is needed to determine the
Financial Statements ending balance in retained earnings.
LO 8
The ending balance in retained earnings is
Financial Statements needed in preparing the balance sheet
LO 8
The balance sheet and income statement are
Financial Statements needed to prepare statement of cash flows.
LO 8
Question
Which of the following financial statements is prepared as
of a specific date?
a. Statement of financial position.
b. Income statement.
c. Retained earnings statement.
d. Statement of cash flows.
Chapter 1
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SEEK WISDOM, ELEVATE YOUR EXCELLENCE & SERVE HUMANITY

AAU School of Commerce Acfn 1031

Fundamentals of Accounting I-AAUSC,

Fundamentals of Accounting I-AAUSC,

Fundamentals of Accounting I-AAUSC,

Fundamentals of Accounting I-AAUSC,

Accounting consists of three basic activities - it

the economic events of an organization to interested users.

Fundamentals of Accounting I-AAUSC,

Three Activities The activities of the

The accounting process includes

Fundamentals of Accounting I-AAUSC,

Fundamentals of Accounting I-AAUSC,

Fundamentals of Accounting I-AAUSC,

Fundamentals of Accounting I-AAUSC,

Fundamentals of Accounting I-AAUSC,

What is the Role of Accounting in

The Role of Accounting in business is to

Fundamentals of Accounting I-AAUSC,

Fundamentals of Accounting I-AAUSC,

Internal Users External Users

Fundamentals of Accounting I-AAUSC,

Who Uses Accounting Data

Fundamentals of Accounting I-AAUSC,

Who Uses Accounting Data

Fundamentals of Accounting I-AAUSC,

Fundamentals of Accounting I-AAUSC,

Fundamentals of Accounting I-AAUSC,

Public Accounting Private Accounting

Government Forensic Accounting

Fundamentals of Accounting I-AAUSC,

The Building Blocks of Accounting

The following are considered to be the building

Fundamentals of Accounting I-AAUSC,

Fundamentals of Accounting I-AAUSC,

The accounting equation and elements of the equation

Assets = Liabilities + Owner’s Equity

Equity = Creditors equity + Owners equity

Provides the underlying framework for recording and summarizing

LO 6 State the accounting equation, and define its components.

Provides the underlying framework for recording and summarizing

Provides the underlying framework for recording and summarizing

LO 6 State the accounting equation, and define its components.

Provides the underlying framework for recording and summarizing

LO 6 State the accounting equation, and define its components.

LO 6 State the accounting equation, and define its components.

Expenses are the cost of assets consumed or services used in the

LO 6 State the accounting equation, and define its components.

Dividends are the distribution of cash or other assets to shareholders.

LO 6 State the accounting equation, and define its components.

Classification Effect on Equity

1. Rent expense Expense Decrease

2. Service revenue Revenue Increase

3. Dividends Equity Decrease

LO 6 State the accounting equation, and define its components.

Transactions are a business’s economic events

 May be external or internal.

 Not all activities represent transactions.

 Each transaction has a dual effect on the