PREPARED BY DR. A.S.

NYANG’AU (PhD)

TOPIC 1: THEORETICAL FRAMEWORK OF ACCOUNTING

Definition- it’s a coherent system of interrelated objectives and fundamentals that can lead to
consistent standards and that prescribes the nature accounting

Importance
– For standard setting
– For better understanding and confidence of financial repotting
– Enhance comparability among companies
– Any new practical problem solved easily

What is accounting?
Accounting is simply a language of business. It’s a man made means of communication of
certain business information. It’s a systematic development of information about economic
affairs of an organization. It derives its usefulness from the social value of the environment in
which it is developed. Its scope and definition change with the passage of time. In general, it is
argued that accounting is concerned with the provision of information about the financial
position, performance and changes in financial position of an enterprise that is useful to a wide
range of potential users in making economic decisions.
Accounting prepares various kinds of reports. It observes the things the organization does, record
their effect and summarize them. It forecast and plans for current and future periods
People involved in accounting are:-
(a) Business owners/ Entrepreneurs
(b) Managers
(c) Bankers.
(d) Stock brokers & lawyers.
Accounting information describes the events that make up the day existence of every business.
Its information is used for controlling the use of resources owned by a business.
It’s also used for measuring the performance of a business entity

Summary: use of accounting information

(a) Describe the events taking place in a business
(b) Used to control resources owned by a business
(c) Used in measuring performance of a business.

History of accounting
(a) History of accounting goes to ancient Mesopotamia in Egypt. Accounting records
were kept as rudimentary documents. Traces of numerical records could be traced in
the early civilization and the ruins of Babylon and accounting for both farms and
estates were kept in Rome.
(b) In Greek and Roman, accounts were mostly based on the “charge & discharge
principles.”
A steward, a public official or other person entrusted with money or property
rendered account periodically to his master during the period of his stewardship.
The “Charge” consisted of the balance due to his master at the beginning of the
period. The “Discharge” consisted of sums disbursed or goods sold or consumed

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during the period, plus the balancing figure of money or goods due to the
accountant’s master.
(c) The next most important development that occurred in Italy was doubled entry book –
keeping in 13th & 14th Century.
The principles of charge & discharge were extended to the cashier of the firm who
was charged with the receipts & discharged with payments
(d) It refinement of the above system was developed by Luca Pacioli (1445-1515).
Luca developed the master system of book keeping and double entry system of
accounting.
He developed the use of journal as a book of original entry and ledger as the book of
accounts. The only notable shortcoming of Pacoili’s system was the failure to
distinguish between the proprietor of a business as an individual & the business as an
entity independent of its own.
(e) The development of modern accounting practices began within the industrial
revolution, the development of the railway, the creation of just stock companies and
as a manger academic discipline. The theory of scientific management has also had
some influence on the development of modern accounting through practices.
(f) The history of book-keeping closely reflects the history of commerce, industrial and
government. Taxation and government regulation become more important and
resulted to increased demand for information.
There are two types of books used in book-keeping (i) a journal (ii) ledgers
A journal contains daily transactions; daily records from journals are entered in
ledgers
What is book-keeping- it’s the art of recording in books of a business. It provides the information
from which accounts are prepared.
Provides (i) current value and equity
(ii) the change in value

The financial accounting environment

The nature of financial Accounting
Accounting can easily be treated as an information system. Purpose of accounting therefore is to
identify, collect, measure & communication of information about economic units’ i.e
-Sole traders: for example, doctor, dentist, small shopkeeper. Each is the sole owner
of his or her business.
-Partnerships: for example, as above. The main difference is that a business formed
under a partnership structure has shared ownership between at least two
people.
-Limited companies: for example, ICI, Marks & Spencer. There are two types of
limited company, namely, private (ltd) and public limited companies
-Other corporations: for example, enterprises owned by the government.
-Not-for-profit organizations Charities: such as Oxfam, Help the Aged, Save the
children.
-Clubs and societies: such as students’ union, golf clubs.
-Government and quasi-governmental bodies: such as local councils,
-Others: such as trusts and mutual associations.

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The users of accounting information are divided into two

1). External Users
2). Internal Users

External Users – Shareholders, Potential investors, creditors, rank & file employees’ customer,
competitors, financial analysts & advisors, brokers, underwriters, the stock exchange, lawyers,
economist, taxing & regulatory authorities, legislature, the financial press departing agencies,
labor unions, trade association, Business, researches, teachers students and the public.
They make decision on:-
a) Whether to invest
b) Whether to extend credits
c) Whether to do business
The process of developing and reporting accounting in formation to external decision makers is
called financial accounting

Finance accounting is concerned with the manner and extent to which business communicate
financial information about themselves to the outside world / public.
Outside world / Public – Individual who invest in them, lend money etc
These people rely on a company’s financial investment and other financial decision related to the
company.

NB/ Many issues involved in the public accounting are controversial, and difference of opinion
& interpretations may have a substantive impact on the public’s decision making process.
Only rarely there is a single, correct resolution or definitive answer to financial accounting
issues.

The accounting body has set a net of accounting concepts principle and procedures to assume
that external financial statements are relevant known as GAAP (General Acceptable Accounting
Principles.)

Internal decision makers – are the managers of an entity

Management is responsible for:-
a) Planning the future of a business
b) Implement plans
c) Control daily operations
d) Dispatch information to other operating officers

The process of developing and reporting financial information for internal users is called
management accounting.

To accomplish the necessary reporting, two basic financial statements are used:-
1. The Balance Sheet – show the company’s financial position as of a specific point
in time. It shows the assets, liabilities and owners’ equity
Also called a statement of financial positions
2. Statements that relate to a specified period of time

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a. Income statement – reports the company revenue, gains, expenses,

losses & net income. Also called the statement of income
b. Statement of retained earnings – reports changes of the company’s
accumulated earnings.
c. Statement of cash flow – report the company cash flow from operating
investing and financial activities.

Features/ characteristics of accounting information

1. Financial reporting should provide information that is useful to present and potential
investors & creditors
2. Information should be comprehensive to those who are reasonably understanding the
business & economic activities
3. Its should help investors and creditors to assess the amounts, timing & uncertainty of
prospective cash receipts
4. To assess the prospects of cash resale redemption & maturity of loan
5. Provide information about the economic resource of an enterprise

Functions of accounting
It is generally accepted that accounting should serve the following functions:
1. Recording: accounting systems supply a means of recording and classifying data
as to enable the production of summarized financial statements relating to the
entity’s results and current state of affairs. Records also enable one-off requests
for data to be complied with.

2. Measuring: accounting tries to assist in the measurement of the economic results of the
entity’s activities, usually with a view to sharing out the results among the various
interested parties: for example, government (taxes), employees (wages),
shareholders (dividends).
3. Stewardship: accounting provides a record of how the funds entrusted to
managers have been used by them, and to what ends.
4. Monitoring, planning and control: accounting should provide sufficient
information on the results of past activities to enable management to monitor
the results, and take action if necessary, and to formulate plans for the future.
5. Information for decisions: accounting should assist investors, for example in
deciding how to allocate their limited resources.
6. Communication: accounting should communicate information to both internal
and external users. (Financial statements are the main tools used to achieve this
function for external users.)
Question
What is the purpose of financial statement information?
Who are the users of accounting information and how do they use the information

Interaction of Financial accounting with its Environment/ importance of financial

reporting
1. Accounting helps decision makers evaluate opportunities by providing measurements
such as net income, total assets etc

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2. It define the tax payment given by the statutory condition

3. Establishes the attractiveness of a company as a takeover target
4. Evaluate the effectiveness of individual managers
5. Determine whether bond & other contract provisions are satisfied
6. Acts as a regulator for decision making
7. Helps lenders to measure the risk of their loans
8. Influence the effectiveness of a company to its workers
9. Suggests bargain strategies for union organizers
10. Affects willingness of supplies to enter into long-term contracts
11. Attracts the attention of the government unit because of unusual profit performance
12. Affects customer’ willingness to purchase company products

Factors that influence accounting information compilation and reporting procedures

1). Accounting principles & standards
2). The legal system of the country Regulatory structure e.g. public untidy regulatory
commission
3). Company dilemma in a competitive environment not the release its information for few
years reducing the competitive advantage
4). The demand for information by the users.
5). The cost and benefits of alternative reporting
6). The importance of the quality of information supplied
7). The development of new financial instruments – e.g. computerization