L1 - Introduction To Financial Accounting (FA)

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L1 – INTRODUCTION TO FINANCIAL ACCOUNTING PREPARED BY FRANCIS ZULU

INTRODUCTION TO FINANCIAL ACCOUNTING

A. DEFINITION AND CONTEXT OF ACCOUNTING

 Accounting is the process of identifying, measuring, recording, classifying, summarizing, interpreting


and communicating economic information to permit informed judgements and decisions by users of the
information.
 From this definition we can conclude that accounting is a process, meaning that accounting has steps
and procedures of doing things. This process involves ; (i) identifying, meaning that accounting is only
concerned with activities or transactions relating to the business; (ii) measuring, meaning that all
activities related to the business should be expressed in monetary terms; (iii) recording, meaning

writing down business transactions in accounting books. This is called bookkeeping. It is concerned with
the recording of financial transactions in an orderly manner, soon after their occurrence in the proper
books of accounts. (iv) classifying, meaning it is concerned with the systematic analysis of the
recorded data so as to accumulate the transactions of similar type at one place. This function is
performed by maintaining the ledger in which different accounts are opened to which related
transactions are posted. (v) summarizing, meaning analyzing all recorded information in categories
and preparing financial statements (Statement of profit or loss (Income Statement), Balance Sheet
(Statement of Financial Position), Statement of Cash flows, Statement of changes in equity and notes
that may be necessary to explain matters relevant but not included in the financial statements. It is
concerned with the preparation and presentation of the classified data in a manner useful to the users;
(vi) interpreting, meaning explain the statements in a manner that is useful to take action. The
accountant should explain not only what has happened but also (a) why it happened, and (b) what is
likely to happen under specified conditions; (vii) communicating, timely reporting of economic
information.
 Financial data is the name given to the actual transactions expressed in monetary terms carried out by
the business (e.g. sales of goods, purchases of goods, payment of goods. These transactions are
recorded primarily in books of prime entry. The transactions are then analyzed in the books of prime
entry and the totals are posted in the ledger accounts (T-accounts). Finally, the transactions are
summarized in the financial statements. This is what is referred to as accounting process.
 Profit, it has been said often, is the sole objective of business. Therefore, for those running a business,
information about the financial performance of the enterprise is a most important requirement. This
information is not available easily and can be obtained only by systematically recording, classifying, and
summarizing all the business transactions. The branch of accounting that accomplishes these
tasks under internationally standardized procedures is called financial accounting.

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L1 – INTRODUCTION TO FINANCIAL ACCOUNTING PREPARED BY FRANCIS ZULU

 However, financial accounting is not limited to recording, classifying, and summarizing information
about business transactions. It also deals with reporting this information to stakeholders outside the
organization, such as investors and creditors, who are the important, primary recipients of the
information. There may be secondary recipients, too, such as competitors, customers, employees, and
stock-market analysts, but the information generated by financial accounting is mainly aimed at
external stakeholders who are not part of the business organization per se. Therefore, to put together a
formal definition of financial accounting, it is a specialized branch of accounting that records
and reports information about the financial position and performance of a company, mainly
for use by the business entity’s external stakeholders.
 Financial Accounting is a specialized branch of accounting that records and reports information under
internationally standardized procedures about the financial position and performance of a company,
mainly for use by the business entity’s external stakeholders.
 How does financial accounting achieve its tasks? Financial accounting mainly generates three financial
statements to provide the information required—the balance sheet, income statement, and cash flow
statement and notes to the accounts. These documents provide the stakeholders a clear idea about the
performance of the business during a particular period and its financial position at a specific time. The
objective of the financial accountants is not to estimate the value of a company but to facilitate this
valuation by others.

 According to the International Financial Reporting Standards, financial accounting provides information
about a business organization that is useful to existing and potential investors, lenders, and other
creditors in making decisions about providing resources to the organization.
 Distinction between book-keeping and accounting. Book-keeping is a part of accounting and is
concerned with the recording of transactions which is often routine and clerical in nature, whereas
accounting performs other functions as well such as measurement and communication, besides
recording. An accountant is required to have a much higher level of knowledge, conceptual
understanding and analytical skill than is required of the bookkeeper. An accountant designs the
accounting system, supervises and checks the work of the bookkeeper, prepares the reports based on
the recorded data and interprets the reports. Nowadays, he is required to take part in matters of
management, control and planning of economic resources.

B. OBJECTIVES/PURPOSES/ROLE OF ACCOUNTING
1. To ascertain the operational profit or loss
 Accounting helps in ascertaining the net profit earned or loss suffered on account of carrying out the
business. This is done by keeping a proper record of revenues and expense of a particular period. The
profit and loss account is prepared at the end of a period and if the amount of revenue for the period is

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more than the expenditure incurred in earning that revenue, there is said to be a profit. In case the
expenditure exceeds the revenue, there is said to be a loss. Profit and loss account will help the
management, investors, creditors, etc. in knowing whether the business has proved to be profitable or
not. In case it has not proved to be profitable, the cause of such a state of affairs will be investigated
and necessary remedial steps will be taken.
2. To ascertain the financial position of the business
 The profit and loss account gives the amount of profit or loss made by the business during a particular
period. However, it is not enough. The businessman must know about his financial position i.e. where
he stands? what he owes and what he owns? This objective is served by the balance sheet or position
statement. The balance sheet is a statement of assets and liabilities of the business on a particular
date. It serves as barometer for ascertaining the financial health of the business. Provide information
about the volume of economic resources (assets) available to the enterprise; its obligations to transfer
part of these economic resources to others (liabilities); the extent of its earnings from operations and
other financial activities; changes in financial position.
3. To facilitate rational decision making
 Provide speedy and objective information on the activities of the enterprise, in order to permit
informed judgement and decisions. Financial statements, accounts and bookkeeping records provide
and communicate useful information to various interested parties for making rational business
decisions. These decisions include: (1) investing decision; (2) financing decision; (3) dividend decision;
(4) divestment decision; (6) acquisition decisions; (7) merger decisions; and (8) restructuring
decision; (9) disposal decision (10) make or buy etc.
4. Planning, Monitoring and control
 Provide information about the firm’s financial plan and budgets; forecasts; non-quantifiable events and
conditions that affect the business. Accurate accounting records enables owners and managers to
monitor what has happened in the business and compare this with what was forecast to happen and
then take corrective action when necessary.
5. Forecasting for the future
 Provide interpretive information to allow prediction, comparison and evaluation of business
performance in terms of its earning power, solvency, gearing, efficient utilization of time and
resources. Based on what has happened historically, owners are able to forecast what they anticipate
will happen in the future, in the form of cash budgets or projected trading and profit and loss accounts
and balance sheets.
6. Compliance with legal requirement
 Businesses have a legal requirement to maintain complete and accurate accounting records, principally
to enable revenue agencies to all amounts due in respect of taxes.

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7. Information System
 Accounting functions as an information system for collecting and communicating economic information
about the business enterprise. This information helps the management in taking appropriate decisions.
This function is gaining tremendous importance these days.
8. To keep systematic records
 Accounting is done to keep a systematic record of financial transactions. In the absence of accounting
there would have been terrific burden on human memory which in most cases would have been
impossible to bear.
9. To protect business properties
 Accounting provides protection to business properties from unjustified and unwarranted use. This is
possible on account of supplying the following information to the manager or the proprietor: (i) The
amount of the proprietor's funds invested in the business; (ii) How much the business have to pay to
others?; (iii) How much the business has to recover from others?; (iv) How much the business has in
the form of (a) fixed assets, (b) cash in hand, (c) cash at bank, (d) stock of raw materials, work-in-
progress and finished goods? Information about the above matters helps the proprietor in assuring
that the funds of the business are not necessarily kept idle or underutilized.

C. LIMITATIONS OF ACCOUNTING
1. Financial accounting permits alternative treatments
 No doubt accounting is based on concepts and it follows "generally accepted accounting principles",
but there exists more than one principle for the treatment of any one item. This permits alternative
treatments within the framework of generally accepted accounting principles. For example, the closing
stock of a business may be valued by any one of the following methods: FIFO (First-in-first-out); LIFO
(Last-in-first-out); Average price, Standard price etc. Application of different methods will give different
results, but the methods are generally accepted. So, the results are not comparable.
2. Financial accounting is Influenced by personal judgements
 Inspite of the fact that convention of objectivity is respected in accounting but to record certain events
estimates have to be made which requires personal judgement. It is very difficult to expect accuracy in
future estimates and objectivity suffers. For example, in order to determine the amount of depreciation
to be charged every year for the use of fixed asset it is required to estimate (a) future life of the asset,
and (b) scrap value of the asset. Thus, in accounting we do not determine but measure the income. In
other words, the income disclosed by accounting is not authoritative but approximation.
3. Financial accounting ignores important non-monetary information
 Financial accounting takes into consideration only those transactions and events which can be
described in money. The transactions and events, however important, if non-monetary in nature are

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ignored i.e., not recorded. For example, extent of competition faced by the business, technical
innovations possessed by the business, loyalty and efficiency of the employees etc. are the important
matters in which management of the business is highly interested but accounting is not tailored to
take note of such matters. Thus, any user of financial information is, naturally, deprived of vital
information which is of non-monetary character.
4. Financial accounting does not provide timely information
 Financial accounting is designed to supply information in the form of statements (Balance Sheet and
Profit and Loss Account) for a period, normally, one year. So, the information is, at best, of historical
interest and only postmortem analysis of the past can be conducted. The business requires timely
information at frequent intervals to enable the management to plan and take corrective action. For
example, if a business has budgeted that during the current year sales should be ZMW1,200,000 then
it requires information – whether the sales in the first month of the year amounted to ZMW 100,000 or
less or more? Traditionally, financial accounting is not supposed to supply information at shorter
intervals than one year.
5. Financial accounting does not provide detailed analysis
 The information supplied by the financial accounting is in reality aggregate of the financial transactions
during the course of the year. Of course, it enables to study the overall results of the business activity
during the accounting period. For proper running of the business the information is required regarding
the cost, revenue and profit of each product but financial accounting does not provide such detailed
information product-wise. For example, if a business has earned a total profit of, say, ZMW500,000
during the accounting year and it sells three products namely maize, rice and groundnuts and wants to
know profit earned by each product. Financial accounting is not likely to help him.

6. Financial accounting does not disclose the present value of the business
 In financial accounting the position of the business as on a particular date is shown by a statement
known as balance sheet. In balance sheet the assets are shown on the basis of going concern concept.
Thus, it is presumed that business has relatively longer life and will continue to exist indefinitely,
hence the asset values are going concern values. The realized value of each asset if sold today can't be
known by studying the balance sheet.

D. BRANCHES OF ACCOUNTING
1. Financial accounting.
 Financial Accounting is a specialized branch of accounting that records and reports information under
internationally standardized procedures about the financial position and performance of a company,
mainly for use by the business entity’s external stakeholders.

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 Financial accounting involves the classification and recording of the monetary transaction of an entity in
accordance with established concepts, principles, accounting standards and legal requirements and
their presentation by means of profit and loss accounts, balance sheet and cash flow statements, during
and at the end of an accounting period.
 Many businesses have a financial accounting system with a nominal ledger, sales ledger and purchases
ledger and books of prime entry for recording transaction that have occurred during a given period.
 The objective of financial accounting is to record the transactions and report on them in order to
ascertain the results (profit or loss) of business operations during the particular period and to state the
financial position (balance sheet) as on a date at the end of the period. The objects of financial
accounting, as stated above, can be achieved only by recording the financial transactions in a
systematic manner according to a set of principles. The art of recording financial transactions and
events in a systematic manner in the books of account is known as book-keeping. However, mere
record of transactions is not enough. The recorded information has to be classified, analyzed and
presented in a manner in which business results and financial position can be ascertained.
 It is primarily concerned with historical nature of the financial information.
 Governed by Generally Accepted Accounting Principles (GAAP) and international accounting
standards.
 Emphasis is more on quantitative data rather than qualitative data.
 Primary focus of preparation is for the external stakeholders.
 Financial accounting is the oldest and other branches have developed from it.
 Limited companies are required by law to prepare financial accounts.
 The law and financial reporting standards prescribe formats of published financial statements.
 Most financial accounting information is of a monetary nature.
 Financial accounts present an essentially historic picture of past operations.
2. Cost accounting.
 Cost accounting is the establishment of budgets, standard costs and actual costs of operations,
processes, activities or products and the analysis of variances profitability or social use of funds.
 The objective of cost accounting is to find out the cost of goods produced, or services rendered by a
business. It also helps the business in controlling the costs by indicating avoidable losses and wastes.
 Cost accounting aims to establish the following: the cost of goods produced or services provided; the
cost of a department or work section; what revenues have been; the profitability of a product, service or
department or the organization in total; selling prices; the value of stocks of goods; future costs of
goods and services; and comparison of actual and budgeted costs

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 A cost accounting system is a system used by an organization to gather, store and analyze data about
costs. The purpose of a cost accounting system is to provide management information about costs and
profits.
 A cost accounting system is often the basis for a management accounting system.
 Cost accounting is part of management accounting. Cost accounting provides a bank of data for the
management accountant to use.
3. Management accounting
 Management accounting is the application of the principles of accounting and financial management to
create, protect, preserve and increase value so as to deliver that value to the stakeholders of profit and
not for profit enterprises both public and private.
 The objective of management accounting is to supply relevant information at appropriate time to the
management to enable it to plan and take decisions and effect control.
 Managers need detailed information about the working of the business to enable them plan, control and
make decisions. The cost and management accounting system provide financial information regarding the
financial aspects of business performance needed by management.
 There is no legal requirement to prepare management accounts.
 Management accounting formats are entirely at the discretion of management.
 Management accounts incorporate both monetary and non-monetary measures.
 Management accounts are both historical record and future planning tool.
4. Tax Accounting
 Tax accounting is a structure of accounting methods focused on taxes rather than the appearance of
public financial statements.
 Tax accounting is governed by the Internal Revenue Code, which dictates the specific rules that
companies, and individuals must follow when preparing their tax returns.
 Tax accounting is the subsector of accounting that deals with the preparations of tax returns and tax
payments.
 Tax accounting is used by individuals, businesses, corporations and other entities.
 Tax accounting for an individual focuses on income, qualifying deductions, donations, and any investment
gains or losses.
 For a business, tax accounting is more complex, with greater scrutiny regarding how funds are spent and
what is or isn't taxable.

E. CHARACTERISTICS OF GOOD QUALITY ACCOUNTING INFORMATION


1. Relevance. Accounting information is relevant if it is connected with what the user wants. That is, it
must influence them to make a decision.

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2. Reliability. Accounting information provided should be depended upon when making decisions. For
accounting information to be reliable it must be audited (examined) by qualified and experienced
auditors so that accounts are free from error, biases and misstatement.
3. Comparability. An exercise undertaken to judge to what extent accounting information is similar or
not similar. For reasonable conclusion to be made about the business it is important that its accounting
information is comparable. When comparing, use similar businesses both in size and nature, or use
accounting information from the same business from previous year. If business is starting for the first
time a budget could also be used.
4. Understandability. For anybody to make a meaningful decision they should have clear knowledge of
what they are looking at. Any difficulties arising from its interpretation must be dealt with by those
who understand it. The information must be clear and easy to understand and this requires proper
presentation.
5. Completeness. When financial statements are prepared, they should have all its parts and should
portray a whole or rounded picture of the business activities.
6. Objectivity. Financial statements should be free from opinions. They should not be prepared in order
to satisfy a particular group. They should be actual facts otherwise they would be considered biased.
The problem of bias is dealt with by external audit. The information must be presented without bias
with respect to the one preparing. The information must be valid, verifiable and based on unbiased
evidence.
7. Timeliness. For information to be meaningful, it should be provided at the time it is required so that
timely decisions could be made. Accounts are usually published soon after the year end.
8. Materiality. Only transactions which are materially significant must be recorded and reported
otherwise, if insignificant transactions are recorded, they may obscure more important matters.
Information is material if its omission or misstatement would influence the economic decisions of users.
9. Faithful representation. All transactions and other events for the period of reporting must be
faithfully recorded and presented.
10. Prudence. Information must be recorded and reported with cautiousness. Assets and incomes must
not be overstated, nor liabilities, expenses and losses be understated.
11. Consistence. Accounting policies upon which financial statements are based should be the same from
year to year. The financial statements should disclose the significant accounting policies that are in use.

F. USERS OF ACCOUNTING INFORMATION


 The basic objective of accounting is to provide information which is useful for persons inside the
organization and for persons or groups outside the organization. Accounting is the discipline that

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provides information on which external and internal users of the information may base decisions that
result in the allocation of economic resources in society.
1. External Users of Accounting Information
 External users are those groups or persons who are outside the organization for whom accounting
function
is performed. Following can be the various external users of accounting information:
 Investors. Potential investors are people with resources but are yet to make a decision as to where to
invest. Those who are interested in investing money in an organization are interested in knowing the
financial health of the organization of know how safe the investment already made is and how safe their
proposed investment will be. To know the financial health, they need accounting information which will
help them in evaluating the past performance and prospects of the organization. Thus, investors for
their investment decisions are dependent upon accounting information included in the financial
statements. They can know the profitability and the financial position of the organization in which they
are interested to make that investment by making a study of the accounting information given in the
financial statements of the organization.
 Creditors. Creditors (i.e. supplier of goods and services on credit, bankers and other lenders of
money) want to know the financial position of a concern before giving loans or granting credit. They
want to be sure that the concern will not experience difficulty in making their payment in time i.e. liquid
position of the concern is satisfactory. To know the liquid position, they need accounting information
relating to current assets, quick assets and current liabilities which is available in the financial
statements. Lenders provide finance to companies in form of loans which could be short or long term.
Their main concern is to whether a company will be able to pay interest on loans and also eventually
repay the loan itself. This information may be provided by accounting information.
 Members of Non-profit Organizations. Members of non-profit organizations such as schools,
colleges, hospitals, clubs, charitable institutions etc. need accounting information to know how their
contributed funds are being utilized and to ascertain if the organization deserves continued support or
support should be withdrawn keeping in view the bad performance depicted by the accounting
information and diverted to another organization. In knowing the performance of such organizations,
criterion will not be the profit made but the main criterion will be the service provided to the society.
 Government and its agencies. Central and State Governments are interested in the accounting
information because they want to know earnings or sales for a particular period for purposes of
taxation. Income tax returns are examples of financial reports which are prepared with information
taken directly from accounting records. Governments also needs accounting information for compiling
statistics concerning business which, in turn helps in compiling national accounts. Regulatory agencies
in environment and many other sectors are interested in the accounting information. Government

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agencies needs to know how the economy is performing in order to plan for financial and industrial
policies. Tax authorities would also want to know the business profits in order to assess the tax payable
by the company. Financial statements could be used as a basis.
 Consumers or customers. Consumers need accounting information for establishing good accounting
control so that cost of production may be reduced with the resultant reduction of the prices of goods
they buy. Sometimes, prices for some goods are fixed by the Government, so it needs accounting
information to fix reasonable prices so that consumers and manufacturers are not exploited. Prices are
fixed keeping in view fair return to manufacturers on their investments shown in the accounting
records.
 Think Tanks or Research Scholars. Accounting information, being a mirror of the financial
performance of a business organization, is of immense value to the research scholars who wants to
make a study to the financial operations of a particular firm. To make a study into the financial
operations of a particular firm, the research scholar needs detailed accounting information relating to
purchases, sales, expenses, cost of materials used, current assets, current liabilities, fixed assets, long
term liabilities and shareholders' funds which is available in the accounting records maintained by the
firm.
 Trade Union. They will need accounting information as a basis for negotiating for improved salaries
and conditions of services.
 The public. People in general want accounting information because enterprises affect them in many
ways. Companies are found where people live. Companies provide jobs for the people and they also
use local suppliers. Companies may also affect the environment through pollution.
 Financial analyst and advisers. These are specialists in economic trends. They need accounting
information in order to advise their clients on best investment options and generally to inform the
public on financial matters.
2. Internal Users of Accounting Information.
 Internal users of accounting information are those persons or groups which are within the
organization. Following are such internal users:
 Owners. A shareholder is a member of limited company and therefore holds one or more shares in
that company. Shareholders are interested in profits and security of their investment. They need
to look at accounting information to access profitability of the company and will make decisions such
as retaining their investment in the company or invest it somewhere else.The owners provide funds
for the operations of a business and they want to know whether their funds are being properly used
or not. They need accounting information to know the profitability and the financial position of the
concern in which they have invested their funds. The financial statements prepared from time to
time from accounting records depicts them the profitability and the financial position.

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 Management. Managers are people appointed by owners of the company to supervise the daily
activities of the company. Managers need accounting information to make planning decisions.
Management is the art of getting work done through others, the management should ensure that
the subordinates are doing work properly. Accounting information is an aid in this respect because it
helps a manager in appraising the performance of the subordinates. Actual performance of the
employees can be compared with the budgeted performance they were expected to achieve, and
remedial action can be taken if the actual performance is not up to the mark. Thus, accounting
information provides "the eyes and ears to management". The most important functions of
management are planning and controlling. Preparation of various budgets, such as sales budget,
production budget, cash budget, capital expenditure budget etc., is an important part of planning
function and the starting point for the preparation of the budgets is the accounting information for
the previous year. Controlling is the function of seeing that programmes laid down in various
budgets are being actually achieved i.e. actual performance ascertained from accounting is
compared with the budgeted performance, enabling the manager to exercise controlling case of
weak performance. Accounting information is also helpful to the management in fixing reasonable
selling prices. In a competitive economy, a price should be based on cost plus a reasonable rate of
return. If a firm quotes a price which exceeds cost plus a reasonable rate of return, it probably will
not get the order. On the other hand, if the firm quotes a price which is less than its cost, it will be
given the order but will incur a loss on account of price being lower than the cost. So, selling prices
should always be fixed on the basis of accounting data to get the reasonable margin of profit on
sales.
 Employees. Employees are interested in the financial position of a concern they serve particularly
when payment of bonus depends upon the size of the profits earned. They seek accounting
information to know that the bonus being paid to them is correct. They have careers to protect.
Employees are workers in a company. Their concern is job security and better conditions of
services. Accounting information may also disclose that the company is threatened with closure and
employees will have to make a decision of staying or not.

G. BUSINESS ORGANIZATION
 Business organization is the single-most important choice you’ll make regarding your company. What
form your business adopts will affect a multitude of factors, many of which will decide your company’s
future. Aligning your goals to your business organization type is an important step, so understanding
the pros and cons of each type is crucial.

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 A business is defined variously to suit one’s requirements. In our studies we shall define a business
as “a person, firm, company or other organizations which makes or produces some kind of service or
goods usually for the purpose of making profits.”
 Your company’s form will affect: how you are taxed; your legal liability; costs of formation; operational
costs.
 Businesses range from basic simple business to a more complex one.
 There are 4 main types of business organization: sole proprietorship, partnership, corporation, and
Limited Liability Company.

1. Sole Trader or Sole Proprietor


 This is the type of business owned and operated by one person. However, the person running this
business can have employees.
 The sole trader, as an individual will provide the resources and skills to operate the business.
 Maintaining accounting records in a sole trader may vary from basic to complex as some sole trader
may grow very big.
 A sole trader is a business owned and run by single proprietor (usually one individual, but it may be
a group of individuals such as a family). The proprietor provides all the financial resources and
makes decisions. You will realize that there may be employees in the firm, and decision-making may
be delegated to some of them, but the final success (profit) or failure (loss) rests with the
proprietor.
 Advantages. (1) Easier to set up than other business entities. A person becomes a sole proprietor
simply by running a business. very few requirements for starting—often only a business license.
 ; (2) The owner maintains 100% control and ownership of the business. By definition, a sole
proprietorship can have only one owner, and that owner is entitled to the profits and control of the
business as such all profits are subject to the owner (3); There is very little regulation for
proprietorships; (4) Owners have total flexibility when running the business;
 Disadvantages. (1) Owner is 100% liable for business debts. The owner is personally liable for any
debts or obligations of the business. This means that lawsuit claimants or creditors may have access
to the owner’s personal accounts, assets, or property if any business accounts cannot cover his
debt; (2) Equity is limited to the owner’s personal resources; (3) Ownership of proprietorship is
difficult to transfer and experiences succession challenges; (4) No distinction between personal and
business income;

2. Partnership
 This is a type of business where two or more persons put their resources together to carry on
business for the purpose of making profits. There is a limit as to the number of partners depending
on the type of business to be carried on.

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 These come in two types: general and limited. In general partnerships, both owners invest their
money, property, labor, etc. to the business and are both 100% liable for business debts. In other
words, even if you invest a little into a general partnership, you are still potentially responsible for
all its debt. General partnerships do not require a formal agreement—partnerships can be verbal or
even implied between the two business owners. Limited partnerships require a formal agreement
between the partners. They must also file a certificate of partnership with the state. Limited
partnerships allow partners to limit their own liability for business debts according to their portion of
ownership or investment.
 In law, it does not require any formal, written agreement (a verbal arrangement is sufficient),
although there are various legal requirements which must be met, such as a limitation on the
numbers of partners (usually twenty, although more are permitted for certain types of partnership).
 Just like sole traders, partnerships do not have a separate legal identity from its owners (partners)
and thus they are, jointly, personally liable for the debts of the business and for meeting the
obligations of contracts on behalf of the partnership.
 Advantages. (1) Shared resources provides more capital for the business; (2) Each partner shares
the total profits of the company; (3) Similar flexibility and simple design of a sole proprietorship;
(4) Easy and inexpensive to establish a business partnership, formal or informal; (5) Businesses as
partnerships do not have to pay income tax as each partner files the profits or losses of the
business on his or her own personal income tax return. This way the business does not get taxed
separately; (6) There is an increased ability to raise funds when there is more than one owner; (7)
Wider pool of knowledge, skills, and contacts; (8) Improved management with more than one
owner.
 Disadvantages. (1) Each partner is 100% responsible for debts and losses; (2) Selling the
business is difficult—requires finding new partner; (3) Partnership ends when any partner decides to
end it; (4) Partners are jointly and severally liable for the actions of other partnership obligations
including contracts, torts, and breaches of trust. Joint and several liability means that if a third party
were to sue the partners, the third party can sue any one of the partners without suing all of them.
If a partner has been sued but cannot pay the third party the full amount, the third party may
collect the money from the remaining partners; (4) Each partner is individually liable for the debts
and obligations of the business; if the business does not have enough assets to pay back business
debts, creditors can take the personal assets of the partners; (5) A partner cannot transfer interest
in the business without the unanimous consent of the partners; (6) Partnerships can potentially be
unstable because of the danger of dissolution if one partner wants to withdrawal from the business
or dies.

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3. Limited Liability Companies

 This is a formal association of persons for business purposes. A company is legally incorporated
(formed) under company law. Members of a company are called shareholders. They become
members by buying shares. Companies are usually limited (Ltd) meaning that if the company goes
into liquidation (closing) because of debts (what it owes), each member will only lose the cost of his
shares i.e. amount contributed in the business and no more.
 Corporations or companies are, for tax purposes, separate entities and are considered a legal
person. This means, among other things, that the profits generated by a corporation are taxed as
the “personal income” of the company. Then, any income distributed to the shareholders as
dividends or profits are taxed again as the personal income of the owners.
 Limited liability companies can be further categorized into:

(i) Private Companies


 You will learn that a private company is restricted to a few known individuals and the public is not
invited to buy its shares. Further to that, the shareholders (owners) cannot transfer their shares
without the agreement of the other shareholders. The name of a private limited company ends with
the words ‘private limited company’ or the abbreviation ‘LTD’

(ii) Public Companies


 The name of a public company ends with the words ‘public limited company’ or the abbreviation
‘PLC’. Unlike private companies, public companies can transfer shares without restrictions. This
means that if you were to walk into a bank, or similar public place, and see a prospectus offering
anyone the chance to take up shares in a company, then that company would be a public company,
i.e. a PLC.
 Advantages. (1) Limits liability of the owner to debts or losses; (2) Profits and losses belong to the
corporation; (3) Can be transferred to new owners fairly easily; (4) Personal assets cannot be
seized to pay for business debts; (5) The profits of the LLC are shared by the owners without
double-taxation

 Disadvantages. (1) Corporate operations are costly; (2) Establishing a corporation is costly due to

legal and filing fees; (3) Start a corporate business requires complex paperwork; (4) With some

exceptions, corporate income is taxed twice; (5) Agreements must be comprehensive and complex;

(6) Serious regulatory scrutiny; (7) Legal requirement to prepare the financial statements.

H. CLASSIFICATION OF BUSINESS ACTIVITIES

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 Business activities may broadly be classified into two categories namely (1) Industry and (2)

Commerce.

 Industry involves production of goods and services whereas commerce is concerned with the

distribution of goods and services.


1. Industry
 The term industry refers to a series of companies that operate in a similar business sphere, and its
categorization is narrower.

 Industry is concerned with the making or manufacturing of goods. It is that constituent of production

which is involved in changing the form of goods at any stage from raw material to the finished product,

e.g., weaving woolen yarn into cloth. Thus, industry imparts ‘form utility’ to goods.

 Industry refers to a much more specific group of companies or businesses, while the term sector

describes a large segment of the economy.

 The terms industry and sector are often used interchangeably to describe a group of companies that

operate in the same segment of the economy or share a similar business type. The term sector often

refers to a larger, general part of the economy, while the word industry is much more specific.

 Industry refers to a specific group of companies that operate in a similar business sphere. Essentially,

industries are created by breaking down sectors into more defined groupings.

 The goods produced may either be used by other enterprises as raw materials for further production,

they are known as “producers’ goods”. The production of plant, machinery equipment etc. are,

examples of producers’ goods. When goods are finally used by consumers they are known as

consumers’ goods. The examples of such goods are cloth, bread, groceries, drugs, etc.

 An enterprise may produce materials which will further be processed by yet another concern for

converting them into finished goods. These goods are known as intermediate goods. The examples of

this category are—plastics, rubber, aluminum, etc.

H1. Classification of industries:

 Industries may be classified as to the types of goods produced, scale of investment and type of

technology employed.

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 On the basis of type of goods produced:

(i) Primary and Genetic Industry

 Genetic industry is related to the re-producing and multiplying of certain species of animals and plants

with the object of earning profits from their sale. Nurseries, cattle breeding, fish hatcheries, poultry

farms are all covered under genetic industry. The plants are grown, and birds and animals are reared

and then sold on profit. No doubt nature, climate and environment play an important part in these

industries, but human skill is also important.

(ii) Extractive Industry:

 The extractive industry is engaged in raising some form of wealth from the soil, climate, air, water or

from beneath the surface of the earth. These industries are classified into two categories. In the first

category, workers merely collect goods already existing.

 Mining, fishing, and hunting is covered in this category. In the second category’, the goods are to be

produced by the application of human skill, i.e., agriculture and forestry. Extractive industries supply

basic raw materials that are mostly the products of the soil. Products of these industries are usually

transformed into many useful products by manufacturing industries.

(iii) Construction Industry

 This industry is engaged in the creation of infra-structure for smooth development of the economy.

It is concerned with the construction, erection or fabrication of products. These industries are

engaged in the construction of buildings, roads, dams, bridges, and canals. These industries use the

products of other industries such as cement, iron, bricks and wood, etc. Engineering and

architectural skills play an important part in construction industry. Engineering and constructing

firms are organised for undertaking operations of construction industry.

(iv) Manufacturing Industry

 This Industry is engaged in the conversion of raw materials into semi-finished or finished goods.

This industry creates form utility in goods by making them suitable for human use. Most of the

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goods which are used by consumers are produced by manufacturing industries. These industries

supply machines, tools and other equipment’s to other industries too.

 The products of extractive industry are generally used as raw materials by manufacturing

industry which may be classified as follows:

(i) Analytical Industry

 In this industry, a product is analyzed, and many products are received as final products. In the

processing of crude oil, we will get kerosene, petrol, gas and diesel, etc.

(ii) Processing Industry

 In this industry a product passes through various processes to become a final product. The finished

product of one process becomes the raw material of the receiving process and soon the final process

produces the finished goods. In case of cotton textiles, cotton passes through ginning, weaving and

dyeing processes to become cloth. Sugar industry and paper industry are other examples of processing.

(iii) Synthetic Industry

 In this industry, many raw materials are brought together in manufacturing process to make a final

product. In manufacturing cement, rocks, gypsum, coal etc. are required. Soap making, paints are the

other examples of synthetic industry.

 On the basis of size and investment

(i) Large Scale Industry

 Though there may not be any hard and fast rule for such classification, but government has fixed

certain limits on investments which differentiate between large scale and small-scale industries. At

present the industries investing more than a certain amount in a given threshold in plant and

machinery in manufacturing units and in ancillary units are covered in large scale sector. Large scale

units are in a position to use latest methods of production and economize on various inputs.

(ii) Small Scale Industry

 The units having an investment up to a certain amount in plant and machinery are small units. A small-

scale unit has the disadvantage of lower production and comparatively higher cost of production.

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 On the basis of technology employed:

 Different units use different types of technology. This classification may be as follows:

(i) Heavy Industry

 The industry engaged in the production of machinery, steel, power generation are called heavy

industry. These units need heavy investments and employ complex technology in production.

(ii) Light Industry

 Industries engaged in producing consumer goods are called light industries. The production technology

is simple, and machinery used is inexpensive.

 On the basis of type of services delivered

 A service industry is any industry that produces value which primarily is intangible such as customer

service, management, advice, knowledge, design, data and experiences. Advanced economies are

experiencing a long-term shift whereby service industries are becoming a larger component of

economic output relative to other industries such as manufacturing and agriculture. The following are

common examples of service industries.

(i) Finance. Financial services such as a bank that offers bank accounts, loans and investments.

(ii) Insurance. Services that cover risks for a fee.

(iii) Professional Services. The services of a recognized professional such as a lawyer or accountant.

(iv) Consulting & Staffing. Offering knowledge and labor as a service.

(v) Information Technology. Information technology is shifting away from products such as

packaged software towards services such as software as a service.

(vi) Hospitality. Any service that hosts guests such as a hotel, restaurant or pub.

(vii) Travel. Travel services such as a flight or tour.

(viii) Transportation. Daily transportation services such as a train.

(ix) Media. Media such as a newspaper, blog or video.

(x) Entertainment. Entertainment such as a video game, theme park or movie.

(xi) Sports. Sports including facilities such as gyms and spectator sports such as professional football.

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(xii) Healthcare. Healthcare services such as a hospital, clinic or doctor's office.

2. Commerce

 All those activities which are connected with taking goods and services from producers to users come

under the purview of commerce. The goal of commerce is to ensure a proper flow of goods and services

for the benefit of both producers and consumers. People are able to buy goods produced anywhere in

the world with the help of commerce.

 Commerce activities may precisely be described as follows:

(i) Commerce is related to the activities dealing with distribution and exchange of goods and services.

These activities relate to trade aspect.

(ii) Commerce covers all these activities which smoothen or help trade. These activities are transport,

banking, insurance, warehousing, advertising, etc. These are ancillary services and are called aids

to trade.

(iii) Commerce is a part of business. Business is a wider concept and includes industry too.

(iv) Commerce is a part of economics. Economics is a study of human beings as consumers and

producers and it has a much wider scope than commerce.

I. SECTORS
 A sector is one of a few general segments in the economy within which a large group of companies can
be categorized.
 Industries are created by breaking down sectors into more defined groupings.
 Sector is a broad term describing the segments of the economy into which large groups of businesses
are categorized. For example, the economy’s basic materials sector includes all companies that deal
with exploration, processing or selling basic or raw materials such as gold or aluminum.
 Industry refers to a more specific grouping of companies whose business activities are very similar.
Essentially, industries are sectors that have been broken down into more defined groups. Each sector
has several industries. For example, the financial sector can be broken down into industries such as life
insurance or banks

 Types of Sectors

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1. Public Sector refers to the part of the Country's overall economy which is controlled by the
Government or various Government bodies. Examples include Ministries, Local Authorities and State-
Owned Enterprises etc.
2. The private Sector refers to the part of the Country's overall economy which is controlled by
Individuals or Private Companies. These include Civil Society Organisation (CSOs).
3. The real sector of an economy is the sectors that produce goods and services. Branches of real sector
include primary sector, secondary sector and tertiary sector. Primary sector: It is a sector which
extract something from nature or earth or creature. It doesn't create anything. For Example: A farmer
harvest crops. He doesn't create it. Secondary Sector: This sector creates goods and services by
changing the formation of another good. For example: Harvesting crops is in primary sector. But when
we use them to create something new it is called secondary sector. Service sector is also a part of
secondary sector which is a branch of real sector. Tertiary Sector: Retailers, entertainment, and
financial companies make up this sector. These companies provide services to consumers.
4. Financial Sector/ Monetary sector: Financial sector engages in taking the surplus money from one
sector to another sector which has deficit of money.

J. AREAS OF PRACTICE
1. Public Practice
2. Business Sector
3. Industry
4. Practitioner
5. Academia
6. Public Sector

K. CAREERS
1. Financial Accountant
2. Accountant
3. Project Accountant
4. Cashier
5. Treasurer
6. Bookkeeper

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