INTRODUCTION TO FINANCIAL ACCOUNTING.

Accounting

Accounting is the process of recording, classifying, summarizing, reporting, analysing and

Accounting is the process of recording, classifying, summarizing, reporting, analysing and
interpreting the financial performance and condition of a business in order to communicate it
to stakeholders for business decision making.

Recording is the stage of accounting circle when transactions are recorded in the accounting
books. Classification means sorting transactions into meaningful groups. Summarizing consists
of accumulation and systematization of accounting data. Analysing and interpretation is the
process of critically assessing financial statements and deriving meaning or conclusions for
further decision making.

Major classification/types of accounting

Accounting can be classified into several types, each serving specific purposes and catering
to different needs. Here are the primary classifications or types of accounting:

1. Financial Accounting

• Purpose: Focuses on preparing financial statements (income statement, balance sheet,

cash flow statement) for external stakeholders such as investors, creditors, and
regulatory bodies.
• Key Features: Follows standardized frameworks like Generally Accepted
Accounting Principles (GAAP) or International Financial Reporting Standards
(IFRS).

2. Management Accounting (Performance management)

• Purpose: Provides information for internal stakeholders (like management) to make

informed decisions regarding operations, budgeting, and performance.
• Key Features: Includes budgeting, cost analysis, and performance evaluation. Not
bound by GAAP/IFRS.

3. Cost Accounting

• Purpose: A subset of management accounting, focusing on calculating and

controlling the costs of production or services.
• Key Features: Helps businesses manage costs and improve efficiency by analysing
direct and indirect costs (materials, labour, overhead).

NOTE: The focus of this module is on financial accounting

Bookkeeping

Bookkeeping is the process of systematically recording business financial transactions on daily

basis. Bookkeeping can be defined as an art of recording business transactions in the books of
accounts in an orderly manner. Much of the work of a book beeper is clerical in nature and
accomplished through manual or computerized system. It involves tracking income, expenses,
and other financial activities in accounting books or computerized systems to ensure accurate
records. A bookkeeper may be responsible for the keeping all records of a business or just a
minor unit of business e.g. Maintenance of customer’s account.

Basically, bookkeeping is the part of the accounting process. It is an important part of the
accounting process as it plays an important role in the early stages in the accounting process.
The end result of Book-Keeping is having net figures or balances that will help to determine a
profit or a loss and the financial position of the business. Apart from profit or loss
determination, Bookkeeping also helps in the management of credit dealings, proper control of
the business and appropriate computation of taxes.

The accounting cycle or accounting process

Accounting cycle is the process that businesses use to prepare financial statements. It is also
known as the accounting process. It is the holistic process of recording and processing all
financial transactions of a business, from when the transaction occurs, to preparation of
financial statement. The accounting process involves eight stages.

The stages in the accounting process are summarised as follows: Eight basic stages in the
accounting cycle:

(i) Identifying transactions and recording in source documents;

(ii) Recording the transactions in the books of prime entry;
(iii) Posting transactions to the ledger accounts;
(iv) Extracting the trial balance;
(v) Making adjusting entries and correction of errors;
(vi) Extracting the adjusted trial balance;
(vii) Preparing financial statements; and
(viii) Analysing and interpreting the financial statements
Differences between bookkeeping and accounting

Bookkeeping and accounting are closely related fields within the financial sector, but they serve
distinct purposes and involve different processes. Below are five key points of difference
between bookkeeping and accounting:

1. Scope of Activities

• Bookkeeping: The scope is narrower, focusing on maintaining ledgers, journals, and

trial balances. It includes tasks like recording sales, purchases, receipts, and payments.

• Accounting: Encompasses a broader range of activities, including preparing financial

statements (like income statements, balance sheets, and cash flow statements),
performing audits, and ensuring compliance with financial regulations.

2. Objective

• Bookkeeping: The main objective is to keep an accurate and complete record of all
financial transactions. It serves as the foundation for the accounting process.

• Accounting: The objective is to interpret and analyze the recorded financial data to
provide valuable insights for decision making. It aims to present a clear picture of the
financial performance and position of the business to stakeholders.

3. Skills Required

• Bookkeeping: Requires clerical skills, that is a basic understanding of financial

transactions, attention to detail, and proficiency in bookkeeping software or systems. It
is more of a clerical or administrative role.

• Accounting: requires higher-level analytical skills, a deep understanding of accounting

principles, knowledge of taxation, auditing, and financial regulations. Accountants
often require advanced qualifications like CPA (Certified Public Accountant) or ACCA
(Association of Chartered Certified Accountants).

4. Outcome

• Bookkeeping: The outcome of bookkeeping is a set of well-organized financial

records. These records are used as the raw data for the accounting process.
 • Accounting: The outcome of accounting is the generation of financial statements, audit
reports, tax returns, and financial forecasts. Accounting provides a basis for decision-
making and strategic planning within the business.

5. Decision-Making Role

• Bookkeeping: Bookkeepers typically do not engage directly in decision-making

processes. Their role is to provide accurate and up-to-date financial data that serves as
the input for decision-making.

• Accounting: Accountants play a critical role in the decision-making process. They

analyze financial data to provide insights and recommendations to management,
helping guide strategic decisions, financial planning, and budgeting.

Fundamental accounting principles or concepts:

Accrual Principle:

The essence of accrual concept is on revenue and expenses recognition. Revenue is recorded
when it is earned or realized rather when cash is received and expenses is recorded when it is
incurred rather than when cash is paid. This helps in matching revenues and expenses within
the same period.

Consistency Principle:

Once a company has chosen an accounting method, it should use it consistently across
accounting periods. This will result to accurate comparisons of financial statements over time.

Going Concern Principle:

This principle assumes that a business will continue to operate indefinitely. Therefore,
enterprise prepare it books of account assuming that the business will continue to operate for
the foreseeable future. That is the business will operate for at least the next accounting period
usually 12 months unless conditions indicate otherwise.

Dual Aspect Principal

This concept requires every financial transaction to be recorded in two different accounts, one
on the debit side and other on credit side. This concept is the basis of double entry system. It is
also basis of the fundamental accounting equation (Assets = Liabilities + Capital)
Matching Principle:

This principle requires expenses to be matched against the revenues they have generated within
the same accounting period when determining profit or loss for the year.

Historical Cost Principle:

Assets are recorded at their original cost of purchase, rather than at current market value. This
is because assets are acquired for the use in the business rather than for sale. The purchase cost
is the basis for all next subsequent accounting for asset.

Materiality Concept:

Only information that could influence the decisions of users of financial statements is
considered material and should be reported. Materiality depends on the amount involved in the
transaction and the nature and size of the business.

Conservatism/ prudence Principle:

This requires understating rather than overstating revenue(income) amount that have a degree
of uncertainty. When in doubt, accountants should choose the solution that results in lower
profits. This ensures that financial statements do not overstate a company’s financial
performance. Financial reports should be prepared with caution, ensuring that revenues or
assets are not overstated, and liabilities or expenses are not understated.

Entity Concept:

The business is treated as a separate entity from its owners. Personal transactions of the owners
should not be included in the business financial records.

Monetary Unit Principle:

Only transactions that can be expressed in monetary terms are recorded in financial statements.
Accounting therefore, records only transactions that can be quantified in monetary terms.

Accounting Period Concept:

the accounting period concept requires the life of the business to be devided into uniform tine
interval. At the end of each period, the financial statements are prepared to establish business
progress. Accounting period is usually the period of 12 months, it can be fiscal year January 1
to December 31 or July 1 to June 30 etc,
ACCOUNTING EQUATION AND DOUBLE ENTRY SYSTEM

ACCOUNTING EQUATION

The accounting equation shows resources owned by a business on one side how those resources
have been financed on the other side.

Mathematically, accounting equation is represented by: Assets = Capital + Liabilities

Assets are resources that an enterprise controls and uses to conduct its business. E.g machine,
equipment, motor vehicles, Also, they include goods kept for sale which are called stock or
inventory and cash.

Capital or owners’ equity refers - to the amount of money or money’s worth contributed by the
owner.

Liability - is defined as the financing from other sources to start or expand a business e.g. Loan
from banks or friends. Liabilities - are resources in the business supplied by non-owners of the
business. They are obligations that a business has to settle by means of transferring economic
resources to other person(s) or business (es).

At a point when the business has just started, the total value of assets equals the value of capital:
ASSETS = CAPITAL.

When a business has resources supplied by the owner of the business and others who do not
own the business, the accounting equation changes as follows:

ASSETS = CAPITAL + LIABILITIES.

Example: 1
Complete the gaps in the following table.
Assets Liabilities Capital
TAS TAS TAS
A 5,000,000 720,000 ?
B 1,120,000 196,000 ?
C 6,720,000 ? 5,000,000
D 7,840,000 ? 6,580,000
E ? 4,660,000 1,590,000
 F ? 2,520,000 7,680,000
Example 2
Complete the gaps in the following table:
Assets Liabilities Capital
(a) 12,500 1,800 ?
(b) 28,000 4,900 ?
(c) 16,800 ? 12,500
(d) 19,600 ? 16,450
(e) ? 6,300 19,200
(f) ? 11,650 39,750

A statement of affairs

A statement of affairs is a statement which lists all assets and liabilities to enable one to
calculate the value of capital.

Example 3.

B Wise is setting up a new business. Before selling anything, he bought a van for £4,500, a
market stall for £2,000 and a stock of goods for £1,500. He did not pay in full for his stock of
goods and still owes £1,000 in respect of them. He borrowed £5,000 from C Fox. After the
events just described, and before trading starts, he has £400 cash in hand and £1,100 cash at
bank. Calculate the amount of his capital.

Example 4
A F Flint is starting a business. Before starting to sell anything, he bought fixtures for £1,200,
a van for £6,000 and a stock of goods for £2,800. Although he has paid in full for the fixtures
and the van, he still owes £1,600 for some of the goods. B Rub lent him £2,500. After the
above, Flint has £200 in the business bank account and £175 cash in hand. You are required to
calculate his capital

Example 4
a) Mr Magabe started a business with cash worth TZS 2,500,000, liabilities TZS 500,000, and
capital TZS?.
Required: i) calculate capital and
ii) prepare the initial statement of the affairs

b) The following transactions took place during the first three days:

Day 1 bought office machinery and paid cash TZS 600,000.

Day 2, purchased goods worth TZS 300,000, on credit from Kibogoyo.

Day 3, sold goods worth TZS 300,000 on credit to Mr Kawawa at TZS 350,000.

Required: For each of the day, prepare a statement of affairs.