Unit 1  Introduction

to Financial
Accounting
LEARNING OUTCOMES
By the end of this unit, you should be able to:
1. Define accounting and book-keeping and their relationships;
2. Identify the accounting cycle;
3. Describe the branches of accounting
4. Explain the usage and importance of accounting;
5. Discuss the role of accounting, its objectives, advantages and
limitations.
6. Explain the qualitative nature of accounting information;
7. Discuss the accounting standards and concepts
8. Apply the accounting equation.

 INTRODUCTION
Accounting is the language of business. Any dealing that involved money requires
accounting. It is a mean of communication where it provides information to assist
individuals and organizations in recording financial transactions, preparing performance
reports and reports that reflect the current financial position, and in assisting in the
decision-making processes of financial statement users.

The history of accounting is thousand of years old during ancient Mesopotamia,

ancient Iran, ancient Egytian and Babylonians. While the modern accounting was
established in 1494 by Luca Pacioli, the Italian mathematician. Then in the
nineteenth century, accounting developed to become more organised profession.
The Institute of Chartered Accountant in England and Wales was founded in 1880
( ICAEW, 2013)

ACTIVITY 1.
Relate TWO (2) activities that involved dealing with money and
ACTIVITY 1.1
how accounting plays its role .
2  Unit 1 Introduction to Financial Accounting

1.1 ACCOUNTING AND BOOK-KEEPING

1.1.1 Accounting
One of the functions of accounting is to provide information so that people can
make decisions, plan, evaluate and control their business. Accounting is defined
as :

“Accounting is the process of identifying, measuring and communicating

economic information to permit informed judgements and decisions by users
of information” - American Accounting Association (AAA, 1966).

Activities covered under Accounting :

a. Identifying the transactions and events

At this stage, the accounting function identifies a transaction that
has money value in an organization. For example:- Payment of rent.

b. Measuring the transactions

The transaction so identified is measured in terms of a common
unit of measurement . For example:- The currency of the country. In
Oman, it will be measured by Omani Rials (RO).

c. Recording of transactions
The transaction so identified is recorded in the books of account
called Journal in a systematic manner

d. Classifying of transactions
All transactions so recorded are classified in a particular order so
that transactions of a similar nature are grouped together in a book
called Ledger. For example:- All rents paid will be shown in one
place under one account.

e. Summarizing of transactions
All classified transactions are summarized in order to be useful to
the users. The transactions of a particular period are grouped
together and statements like Trial Balance and Financial Statements.
 Unit 1 Introduction to Financial Accounting  3

f. Analyzing the transactions

The relationships between different elements of the financial statement
are established.

g. Interpretation
Explains the meaning and importance of the analysis made.

h. Communication
Refers to communicating the summarized, analyzed and interpreted
information to the users to take decisions.

A systematic knowledge of accounting is called accountancy.

ACTIVITY 2
Imagine you are a dealer in new cars. Identify FIVE(5) business
transactions concerning your business and express then in money value.

1.1.2 Bookkeeping
Bookkeeping is a part of Accounting. It refers only to record keeping and
maintaining books of account. The activities concerned with book keeping
are as shown in Figure 1. It is the initial step in the accounting process.

Figure 1: Activities in Bookkeeping and Accounting Process

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1.1.3 BOOK-KEEPING VS. ACCOUNTING

Differences between Book Keeping and Accounting

Basis Book Keeping Accounting

Nature Identify transactions, Interpret the results and

measure transactions, communicate
record and classify

Objective Maintain records Ascertain the results

and communicate to the
users

Analytical skills Not required Required

Competence Basic level of Higher level of

accounting accounting

SELF CHECK 1.1

State Eight (8) steps in the accounting process.

1.2 ACCOUNTING CYCLE

Accounting cycle refers to a sequential order which starts from recording
of transactions and ends with preparation of financial statements. The
different steps are :
Unit 1 Introduction to Financial Accounting  5
6  Unit 1 Introduction to Financial Accounting

Figure 1.2: Accounting Cycle

ACTIVITY 3
A source document is a basic material/evidence used for recording
purposes.There are many types of source documents for its own usage.
Identify the types and usage of source documents. Then, discuss.

1.3 BRANCHES OF ACCOUNTING

Economic development and increase in the size of enterprises have given
rise to specialized branches of accounting. They are :

1. Financial Accounting :The purpose of this branch is to keep a systematic

record of financial statements, summarize and analyze them and
communicate to the users of the information.

2. Cost Accounting : This branch of accounting examines, ascertains and

controls the costs of products, processes and services.

3. Management Accounting : This branch of accounting provides all

information required by the management to take correct decisions. This
branch uses information generated by financial accounting as well as cost
accounting.

4. Auditing : This branch of accounting is defined as ‘the independent examination of

and the expression of an opinion on the financial statements of an enterprise”. It
involves in assessing the internal controls within the enterprise and examining the books
of accounts and records.

5. Tax Accounting : This branch involves the computation of tax liability, preparation of
tax returns and tax planning.
 Unit 1 Introduction to Financial Accounting  7

SELF CHECK 1.1

1.4 USAGE AND IMPORTANCE OF

ACCOUNTING INFORMATION
1.4.1 Users and Their Needs of Accounting Information

No User Need
1 Management To know if the business is performing as planned
and the future course of action to be taken
2 Government To understand how the economy is performing and
to frame economic and taxation policies
3 Taxation To assess the tax liability of the enterprise
Authorities
4 Employees To assess the strength of their employers, their job
security and growth prospects.
5 Creditors To know the credit worthiness of the company and
if their money is safe
6 Investors The current investors would like to know if their
investment is safe, whether to buy more shares,
sell or hold. Prospective investors would like to
know if they should invest in the company
7 Public To know the service to the society in terms of
employment generation, welfare measures etc.
8  Unit 1 Introduction to Financial Accounting

1.4.2 Importance of Accounting Information

1. It can provide a picture of the fiinancial position of a business.

2. It can assist the users to identify the financial position of an organization,

whether the company is making a profit or a loss and the necessary follow-up
actions that should be taken.

3. It ensures that transactions are recorded for future reference.

1.5 ROLES OF ACCOUNTING AND ITS

OBJECTIVES, ADVANTAGES AND
LIMITATIONS

1.5.1 Role of Accounting

Accounting performs the role of a language. Its primary function is to
communicate the accounting information to the users of the information
in a way they understand it.

Input Recording
Financial Classifyng Convey the
transactions Summarizing information
measured Analyzing to users
Interpreting

The role of accounting is to perform the above functions which are

normally performed by a language.
 Unit 1 Introduction to Financial Accounting  9

1.5.2 Objectives of Accounting

Primary Objectives of Accounting :

To maintain
systematic
records of
accounting

To establish
the financial

performance To
determine
the financial
position

To convey
to the
users

1.5.3 Advantages of Accounting

1. Accounting helps in determining the financial results and financial
position of a given period

2. It facilitates comparison with different periods, other organizations etc

and to take right decisions by users

3. It helps in complying with the law and the legal requirements and tax
payments

4. Facilitates the valuation and to calculate the net worth of the business
10  Unit 1 Introduction to Financial Accounting

1.5.4 Limitations of Accounting :

1. Accounting only looks at the monetary aspect. It does not take into
consideration the quality aspects. ie. Quality of Management / Workforce /
Team spirit etc.

2. Does not take into consideration the price level changes when the
financial statements are prepared on historical cost basis.

3. There can be personal bias in accounting

4. There is a danger of window dressing

ACTIVITY 4.
Identify THREE (3) sole proprietorship in Salalah.
List down TWO (2) characteristics of a sole proprietorship.
Describe how accounting information is used by the enterprises
indentified.

1.6 QUALITATIVE NATURE OF ACCOUNTING

INFORMATION AND GENERALLY
ACCEPTABLE ACCOUNTING PRINCIPLES
1.6.1 Qualitative Nature of Accounting Information

The qualitative nature refers to the features that make the accounting
information useful to the users. The four main features are :

a. Understandability : The financial statements must be understood by the

users of the statement, in the way they are prepared and conveyed to
them.
 Unit 1 Introduction to Financial Accounting  11

b. Relevance : The information become relevant to the users when they

are able to evaluate the past, present and foresee the future.

c. Reliability : to be reliable, the information provided should be correct

and free from material error and bias. The information should be relied
upon by the users.

d. Comparability : The users of the financial statements must be in a

position to compare the statements with those of the past periods and
with those of other entities. ie. By adopting International Accounting
Standards.

1.6.2 Generally Accepted Accounting Principles

Generally Accepted Accounting Principles may be defined as rules of

accounting. They are developed considering the following :

a. Whether a principle is relevant and useful to the users of accounting

information.

b. Whether the principle is feasible to be implemented without much cost

or difficulty.

c. Whether a principle is free from bias

12  Unit 1 Introduction to Financial Accounting

1.7 ACCOUNTING STANDARDS AND

CONCEPTS

1.7.1 Accounting Standards

Accounting Standards are a set of accounting rules and procedures to
prepare credible and reliable financial statements. The purpose of these
standards is to bring uniformity in the presentation of financial statements.

1.7.2 Accounting Concepts

Accounting concepts are a general set of rules that give direction as to
how accounting transactions are to be recorded. According to the Financial
Accounting Standards Board (FASB), following are the basic accounting
concepts :

No. Accounting Explanation

Concept
1 Business This concept states that a business should be treated
Entity as a separate entity different from its owners.
Distinction has to be made between the personal
transactions of owners and those of the entity.
2 Dual Aspect This concept implies that every transaction has two
aspects. This is the basis for double entry system.

3 Going This concept implies the entity will continue its

Concern operations into the foreseeable future and will not
liquidate. It is because of this principle assets are
classified as fixed assets and current assets, liabilities
are classified as short term and long term.

4 Money This concept states that only those transactions which

Measurement can be measured and expressed in terms of money
are included in accounting records.
 Unit 1 Introduction to Financial Accounting  13

5 Historical This concept states, an asset is recorded in the books

Cost of account at the cost at which it is purchased. The
justification for this concept is that it can be easily
verified.

6 Accounting This concept is also known as Time Period Principle. It

Period states that the economic life of an entity is split into
time periods known as accounting periods. Accounting
period generally consists of 12 months ie. one financial
year. Financial Statements are prepared for each year
based on this principle.

7 Conservation According to this concept, the entity should account

for all possible expenses and losses but should not
anticipate profits or gains. Eg: Making provisions for
doubtful debts, valuation of stocks at lower of cost or
market value.

8 Realization According to this concept, revenue is recognized when

the goods or services are delivered and not when
the cash is received.

9 Matching According to this concept, revenue recognized during

an accounting period should be matched with
expenses incurred during that period.

10 Consistency This concept states that the accounting practice that is

adopted by the entity, is to be consistently followed.
Eg: if the entity follows FIFO method of stock keeping,
this method should be followed year after year.

11 Materiality This concept states that the financial statements need

not disclose items and events having an insignificant
economic effect or that are irrelevant to the users of
the statements. This principle is an exception to the
principle of full disclosure. What is insignificant is a
matter of judgement. Eg: Treating calculators as assets
in the balance sheet may not be justified.
14  Unit 1 Introduction to Financial Accounting

Activity 5

State the accounting concept against each of the following :

1. The business will continue in existence and will not be liquidated.

2. All assets are recorded at the cost they are bought

3. The company has been preparing its financial statements at the end of
12 months - January to December

4. Personal transactions of the owner are treated separate from the

business transactions.

5. All transactions are recorded in Rial Omani

6. Recognition of expenses in the same period in which the revenue is

earned.

1.8 BASIC ACCOUNTING EQUATION

An accounting equation helps us understand how these are related to one

another

Assets = Liabilities + Owners' Equity

Example 1:
Let us assume that Mr. Mohammed starts a business called Dhofar
Enterprises on 1st January, 2017 and invests cash of RO. 10,000 as his
capital. The effect of this on the accounting equation is :

Cash (asset) has increased by RO. 10,000 and so has Owner's Equity

Assets = Liabilities + Owners' Equity

10,000 = 0 + 10,000
 Unit 1 Introduction to Financial Accounting  15

Example 2 :
The company purchases machinery worth RO. 2,000. The effect of this is
as follows :

Asset (machinery) has increased by RO. 2,000 and asset (cash) has decreased
by RO. 2000

Assets = Liabilities + Owners' Equity

+2,000 (machinery) = 0 +

-2000 (Cash )

Example 3:
The company purchased goods worth RO. 8,000 for cash :

Here, the asset ( stock of goods) has increased by RO. 8,000 and asset (cash)
has decreased by RO. 8,000

Assets = Liabilities + Owners' Equity

+8,000 (stock of = 0 +
goods)

-8000 (Cash )

Example 4 :
The company purchased goods worth RO. 40,000 on credit :

Here, the asset (stock of goods) has increased by RO. 40,000 and liability
(payable to the supplier) has increased by RO. 40,000

Assets = Liabilities + Owners' Equity

+40,000 = 40,000 +
(stock of goods) (payable to
the supplier)
16  Unit 1 Introduction to Financial Accounting

Example 5 :
Purchased goods worth RO. 21,000 Paid RO. 10,000 cash and balance RO.
11,000 on credit :

Here, the asset (stock of goods) has increased by RO. 21,000, asset (cash)
has decreased by RO. 10,000 and Liabilities (payable to supplier) has
increased by RO. 11,000.

Assets = Liabilities + Owners' Equity

+21,000 = 11,000 +
(stock of goods) (payable to
supplier)
-10000 (cash)

Example 6 :
Sold goods on credit RO. 25,000 ( cost being RO 19000) :

Here, the asset (stock of goods) has decreased by RO. 19,000 , profit of RO
6000 which increases the owners Equity and asset ( receivable from the
customer) has increased by RO. 25,000
Assets = Liabilities + Owners' Equity
-19,000 = + + 6000
(stock of goods)

+25,000
(Receivable from
customer)
 Unit 1 Introduction to Financial Accounting  17

Activity 6: Answer the following questions

Question 1.

Record the following transactions in an accounting equation form:

a. Mr. Mohammed contributed as capital cash RO 400000 to his new business .

b. The company purchased machinery worth RO. 5,000 on cash basis.

c. The company bought goods worth RO. 20,000. For cash RO. 5,000 and
on credit RO. 15,000

d. The company made a sale of RO. 50,000 ( cost of the goods being RO
32000 ) on cash basis .
18  Unit 1 Introduction to Financial Accounting

Question 2.

Record the following transactions in an accounting equation form:

a. Mr. Khalid contributed RO. 25,000 as his total capital for his new
business. He contributed machinery costing RO. 15,000 and balance in
cash.

b. The company purchased a vehicle costing RO. 20,000 on credit

c. The company bought goods worth RO. 35,000. For cash RO.15,000 and
the balance on credit.

d. The company made a sale of RO. 40,000 ( cost RO 31000) on cash basis .
 Unit 1 Introduction to Financial Accounting  19

Question 3.

Record the following transactions in an accounting equation form:

1. Mr. Ibrahim started his business by contributing RO. 55,000 as his capital

2. The company took loan of RO. 10,000 from Bank Muscat

3. The Company bought office furniture worth RO. 5,000 and made 30%
cash as part payment. The balance was on credit.

4. The company purchased goods worth RO. 12,000 on account .

20  Unit 1 Introduction to Financial Accounting

Question 4.

The following transactions need to be recorded in an equation form:

1. Mr. Ahmed contributed RO. 75,000 in cash as his capital towards his new
business.

2. The company bought goods worth RO. 15,000 on cash basis .

3. The company made a sale of RO. 18,000 ( cost was OR 13000), on credit
basis.

4. Mr. Ahmed withdrew RO. 1,000 from the business for his personal use.
 Unit 1 Introduction to Financial Accounting  21

Question 5.

Put the following in equation form :

1. The capital of a new business started by Mr. Rehman had a total capital
of RO. 20,000. He transferred a building valued at RO. 16,000 to the
business and the balance in cash.

2. The company took a loan of RO. 5,000 from Bank Sohar

3. The company bought a machinery RO 9,000 on cash basis.

4. Stock worth RO. 8,000 was bought by making a part payment of RO.
3,000. The balance was on account.

5. The company made a sale of RO. 10,000 ( cost being RO 11500) . Received RO
7500 as part payment and balance was on account.

SELF
SELF CHECK
CHECK 1.11.2
22  Unit 1 Introduction to Financial Accounting

• American Accounting Association (AAA, 1966)

• Timeline of the History of the Accountancy profession, Institute of Chartered

Accountants in England and Wales, 2013

• Lazar, Jane (2010). Accounting and Finance for non-accountants. Leeds

Publications (M) Sdn Bhd.

• Heng Seai Kie (2013). Fundamental of Accounting. Oxford Fajar Sdn Bhd.