Learning

Area 1:
CHAPTER 1 Chapter 1
Introduction to accounting
OUTCOMES
At the end of this chapter students should be able to:

• Define the purpose and nature of accounting.

• Identify the main users of accounting information.

• Describe and explain the four main qualitative characteristics that

influence the usefulness of accounting information.

• Describe various business forms found in South Africa and types

of business activity.

• Understand the considerations to be made before a business can

commence.

• Explain the major differences between financial accounting and

management accounting.
CHAPTER OUTLINE
1.1 What is accounting?

1.2 Users of accounting information

1.3 How useful is accounting information?

1.4 The basic business forms found in South Africa

1.5 Types of business activity

1.6 Considerations before commencing a business

1.7 The accounting field

1.1 WHAT IS ACCOUNTING?
Definition of accounting
Accounting is a system of G-A-R-R-I:

• Gathering – bringing together of all financial information that

has an effect on a specific business
• Analysing – determining how the financial information will
affect the business
• Recording – inputting the financial information through proper
accounting processes
• Reporting – summarizing all financial information for a given
period of time so that it can be read and understood in a more
condensed format
• Interpreting – preparing an analysis of the summarized
reports to allow users to make informed decisions about the
business.
 WHAT IS ACCOUNTING?

1.1 WHAT IS ACCOUNTING?

Nature of accounting
Accounting is…

• A rapidly changing field - reacting in response to the

changes that occur in the external environment.

• A means of communication used to convey a message

about the finances of a business.

• A provider of both financial and non-financial information to

users who use it to make informed decisions. However, it is
important that the users of financial information understand
it, or else it is of no value.
1.2 USERS OF ACCOUNTING INFORMATION
Users of accounting information can be divided into two
groups, namely, internal users and external users:
Internal users
• Owners
• Managers
• Employees and their representatives

External users
• Customers
• Competitors
• Lenders
• Government
• Suppliers
• Investment analysts
1.3 HOW USEFUL IS ACCOUNTING INFORMATION?

There are two main qualitative characteristics that influence the

usefulness of accounting information; Relevance and Faithful
representation.
There are four main qualitative characteristics that enhance the
usefulness of financial information:

Comparability - Must be comparable to the financial information presented by

other organisations and also various accounting periods within the
organisation.
Understandability - Must be readily understandable by all users of financial
statements.
Timeliness – Information must be published within reasonable time after the
financial year end.
Verifiability – It must assure users that the information represents faithfully
what it purports to represents and it can be audited.
1.3 THE BASIC BUSINESS FORMS FOUND IN
SOUTH AFRICA

The basic business forms in South Africa are the sole trader,
partnership, close corporation and company.

Sole trader (1)

• This type of business has one (1) owner.
• The owner supplies the capital to start the business.
• There are no legal formalities other than a licence to trade.
• The owner is taxed on business profits in his own hands.
• The business is not a distinct legal person, that is, has no
legal personality.
1.3 THE BASIC BUSINESS FORMS FOUND IN
SOUTH AFRICA

Sole trader (cont’d)

• The owner is independent

• The owner is directly involved with customers/clients and
can supervise staff closely
• Decisions can be taken quickly, and the business can be
adapted to take advantage of business opportunities.
1.3 THE BASIC BUSINESS FORMS FOUND IN
SOUTH AFRICA

Sole trader (cont’d)

• Expansion prospects are hampered by the limited access to capital.

• The owner is personally liable or has unlimited liability for the debts
of the business – should the business fail to pay its own debts.
• Due to the unlimited nature of the liability, creditors can have access
to the owner’s personal assets for the payment of debts of the
organisation.
• The owner may not be versatile or skilled enough to do everything
for the entity.
• There is no continuity of operations, should the owner die or retire.
1.3 THE BASIC BUSINESS FORMS FOUND IN
SOUTH AFRICA

Partnership (2 – 20)
• This is a legal relationship that exists between two to 20 people
carrying on a business for the purpose of making a profit.

• Each partner’s profits are taxed in his own hands, similar to a

sole trader.

• New partners bring in additional capital and introduce new ideas.

• Partners can specialise in different areas.
• Increased capital and division of labour between partners
facilitate expansion of the business.
1.3 THE BASIC BUSINESS FORMS FOUND IN
SOUTH AFRICA

Partnership (cont’d)

• Partners are jointly and severally liable, meaning that if the partnership
is unable to pay a debt, then the partners will have to contribute from
their personal assets. In the event that a partner is unable to contribute
his portion, the remaining partners will have to make up the shortfall.
• Ownership by a partner is not easily transferable - a new partnership
must be formed when a partner wants to exit the partnership.
• The continued existence of a partnership is limited as a partnership
ceases to exist when a partner wishes to sell or dies.
• The funds available for the activites of the business are limited to the
combined funding of the partners. This can limit expansion or growth.
1.3 THE BASIC BUSINESS FORMS FOUND IN
SOUTH AFRICA

Close corporation (CC) (1 - 10)

• A close corporation (CC) is a legal entity unique to South Africa
and was established in terms of the Close Corporations Act 69 of
1984.
• When the Companies Act 71 of 2008 came into effect in May
2011, the registration of new CCs was no longer possible.
• CCs that were registered before to the Companies Act of 2008
coming into effect, are still allowed to operate.
• A CC is formed when the members lodge a founding statement
(similar to a constitution) with the Registrar of CCs.
• A CC can have between one and 10 members, who are natural
persons.
1.3 THE BASIC BUSINESS FORMS FOUND IN
SOUTH AFRICA

Close corporation (cont’d)

• A close corporation (CC) is a legal entity or juristic person. It
can sue or be sued in its own right.
• It is taxed in its own hands (figuratively) at the same rates as
companies, that is, income is not taxed in the hands of the
members.

• Members enjoy limited liability. The liability of the members is

limited to the amount they have contributed to the CC.
• A CC enjoys perpetual succession.
1.3 THE BASIC BUSINESS FORMS FOUND IN
SOUTH AFRICA

Close corporation (cont’d)

• Members only become liable when certain rules are breached.

• An audit of the books is not required by law. Banks, creditors
and the South African Revenue Service (SARS) may,
however, request audited financial statements.

• A CC may acquire shares in a company, but a company

cannot acquire membership in a CC.
1.3 THE BASIC BUSINESS FORMS FOUND IN
SOUTH AFRICA

Close corporation (cont’d)

• Restriction of the number of members to 10 limits the capital

and possible growth of the business.
• A CC is taxed at the same rate as a company – which is a
higher rate than a sole trader or partnership.
• In order for a member to leave the CC or be paid out, all
members have to agree to dispose of a member’s interest.
1.3 THE BASIC BUSINESS FORMS FOUND IN
SOUTH AFRICA

Companies (1 or more persons)

• A company is a legal organisation different from its “owners”
who are referred to as shareholders and can be one or more
individuals and/or organisations.

• According to the Companies Act of 2008, all companies fall

under two broad categories:

1. Profit companies (Private, public, personal liability and state-

owned enterprises)
2. Non-profit companies (reflected as NPC)

For our purposes, we will focus on 1) profit companies; in

particular private and public.
1.3 THE BASIC BUSINESS FORMS FOUND IN
SOUTH AFRICA

Companies (cont’d)
• The formation and activities of a company are regulated by the
Companies Act of 2008, making a company much more
complicated and expensive to form than any other business.

• The registration of a company must be made at the Companies and

Intellectual Property Commission (CIPC).

• A company is a distinct and separate legal entity apart from its

shareholders.

• Shareholders enjoy limited liability. Unlike a sole trader and a

partnership, the shareholders do not have to pay the company’s
debt if it cannot do so itself.

• A company is managed by the board of directors, which is headed

by the CEO.
1.3 THE BASIC BUSINESS FORMS FOUND IN
SOUTH AFRICA

Companies (cont’d)

Private companies

• A private company is an organisation made up of one or

more persons.
• Its name ends with the words “Proprietary Limited (Pty Ltd)”
• It is governed by the Companies Act of 2008 and is
incorporated in terms of the Memorandum of Incorporation
(MOI).
• It is prohibited from offering its shares to the public. This
means that the transferability of shares is restricted.
1.3 THE BASIC BUSINESS FORMS FOUND IN
SOUTH AFRICA

Companies (cont’d)

Public companies
• A public company is an organisation made up of one or
more persons.
• Its name ends with the word “Limited (Ltd).”
• It is governed by the Companies Act 71 of 2008 and is
incorporated in terms of the MOI.
• Securities are issued through an initial public offering (IPO)
and are traded on an open market such as the
Johannesburg Stock Exchange (JSE).
1.3 THE BASIC BUSINESS FORMS FOUND IN
SOUTH AFRICA

Companies (cont’d)

Public companies – Advantages!!

• The limited liability of the shareholders ensures that
shareholders are not responsible for the debts of the
company.
• There is improved access to capital which in turn can
stimulate growth.
• A company enjoys perpetual succession. The unlimited life
of the company ensures that investors can keep their
shares as a long-term investment.
 THE BASIC BUSINESS FORMS FOUND IN SOUTH AFRICA
Company

Table 1.1 - The difference between public and private companies

 THE BASIC BUSINESS FORMS FOUND IN SOUTH AFRICA
Companies

Table 1.1 - The difference between public and private companies continued
 THE BASIC BUSINESS FORMS FOUND IN SOUTH AFRICA

Table 1.2 - Comparison of the characteristics of each business form

 THE BASIC BUSINESS FORMS FOUND IN SOUTH AFRICA
Company
Table 1.2 - Comparison of the characteristics of each business form continued
 THE BASIC BUSINESS FORMS FOUND IN SOUTH AFRICA
Company
Table 1.2 - Comparison of the characteristics of each business form continued
1.5 TYPES OF BUSINESS ACTIVITY
The various types of business activity include service business,
manufacturers, wholesalers and retailers.

Service businesses
• This business provides a service for which it charges a fee.
The fees received for the services rendered are called “fee
income”.

• For e.g. plumbers, attorneys, accountants, architects,

hairstylists, electricians and computer repair persons.
1.5 TYPES OF BUSINESS ACTIVITY
Manufacturers
• These businesses buy raw materials that they then
transform into a finished product.
• The raw materials are not always raw material in their true
sense.
• The manufacturer physically makes or produces the goods
and sells them to wholesalers and retailers.

Wholesalers
Wholesalers are often termed “middlemen”, because they buy
in bulk from the manufacturer and then supply the goods in a
slightly smaller quantity to the retailer. In some instances,
wholesalers can sell to the public.
1.5 TYPES OF BUSINESS ACTIVITY
Retailers
• Retailers buy goods from the wholesalers or manufacturers
and then sell these goods at a mark-up to the general public
(consumers).
• The cost price of the product plus the mark-up gives the
selling price.

The activities of retailers include;

• Bring goods within the reach of the consumer.
• Allow the consumer to buy on credit.
• Pay attention to the needs of their consumers.
• Sell goods in small quantities.
• Make consumers aware of new products to the market
• Offer convenience shopping.
1.6 CONSIDERATIONS BEFORE COMMENCING A
BUSINESS

The type of business activity

There is always a risk that a business can fail. Therefore, the
entrepreneur needs to constantly adapt his/her business
strategy to the ever-changing dynamic nature of business,
regardless of the underlying business activity. Use the strategy
known as SWOT analysis.

The entity form

The decision of which business form the proposed business
will be is significant because of the impact on continuity and
control of the business, as well as factors such as taxation and
regulatory responsibilities.
1.6 CONSIDERATIONS BEFORE COMMENCING A
BUSINESS (CONT’D)

The location of the business

• Relative transport costs must be considered when deciding
either to locate close to the source of raw materials or close to
the market which will purchase the goods.
• The availability of suitable premises and the proximity of
appropriate employees for the business will all contribute
towards the probable success.
1.6 CONSIDERATIONS BEFORE COMMENCING A
BUSINESS (CONT’D)

Capital requirements

• All businesses require capital in order to purchase the assets

which are needed for the business to function.
• The credit facilities customers will be allowed will determine the
amount of capital required to commence business.
• Funds for daily expenses and the payment of wages and
salaries also need to be considered.
• Once the amount of capital required has been determined, a
plan or budget of future revenue and expenses is drafted.
1.7 THE ACCOUNTING FIELD

External reporting - to meet the needs of those who

have an interest in the business but who do not
participate in the running of the business.

Internal reporting - to meet the needs of those who are

actively engaged in the management of the business.
1.7 THE ACCOUNTING FIELD (CONT’D)
This is where financial accounting, management accounting +
tax and auditing play a role:

Financial accounting

• Process of recording and reporting information to external

users.
• Financial accounting is governed by accounting standards
issued by the Financial Accounting Standards Board (FASB)
and the International Accounting Standards Board (IASB),
• The rules for communicating in accounting language are set
out in detail in the International Financial Reporting
Standards (IFRS).
1.7 THE ACCOUNTING FIELD (CONT’D)
This is where financial accounting, management accounting +
tax and auditing play a role:

Management accounting
• Reporting of financial information to internal users such as
the managers of the business.
• Financial information is provided for specific purposes which
managers can use in their decision-making, and which leads
to the attainment of the objectives of the organisation.
1.7 THE ACCOUNTING FIELD (CONT’D)
This is where financial accounting, management accounting +
tax and auditing play a role:

Tax
• This field is concerned with the proper compliance with tax
regulations, tax filings and tax planning to reduce a
company’s tax burden in the future.

Auditing
• Include internal and external auditing.
• Internal auditing involves the examination of systems and
transactions to see if they operate as intended and the
reporting of these findings to management.
• External auditing involves the examination of accounting
records to see if the auditor can attest to the fairness of the
information presented in the financial statements.
 THE ACCOUNTING FIELD

Table 1.3 - The major differences between financial accounting and management
accounting
 THE ACCOUNTING FIELD
Table 1.3 - The major differences between financial accounting and management accounting continued
HOMEWORK
Chapter 1 – Introduction to accounting

• Please do Tutorial Exercises 1 – 4 (pgs. 12-14).