What is accounting?

Accounting is the art of recording, classifying and summarizing in a significant manner and in
terms of money, transactions and events which are at least of a financial nature and interpreting
the results thereof.
Users of accounting information
There are both internal and external users.
a) Investors – These includes present and potential investors.
These are providers of risk capital and are concerned about the inherent risks and returns.
They need information to help them determine whether they should buy, hold or sell the
investments. Shareholders also need information to assess whether a company can afford
to pay dividends as profitability does not necessarily imply a healthy cash flow.
b) Employees – They are interested in the stability and profitability of employers. They need
to assess the ability of a company to provide salary, retirement benefits and employment
opportunities.
c) Lenders – They are interested in information that enables them to determine whether their
loans and interest accruing will be paid when due.
d) Creditors – They are interested in whether the amounts owed will be paid when due.
They are usually interested in the short term position.
e) Customers – They are interested in the continuity of a company. They a continuous
supply of raw materials.
f) Government – The government regulates the activities of businesses and determines the
taxation policies. The national budget is heavily financed by taxes from the businesses.
g) Public – Businesses employ members of the public and patronize local suppliers. The
public needs to know the trends and recent developments of businesses. They make
decisions based on the spillover effects of the businesses in their local environment.

There are many users of accounting information. It is not possible to satisfy all the users
at the same time. Some information needs are common to users while others are in
conflict.
The accountant should try to be neutral. He uses certain principles and conventions.
Principles are based on logic and conventions on practice.
The accountant should prepare general purpose financial statements that should provide
information that is useful to a wide range of users in making economic decisions.

PURPOSE OF ACCOUNTING
The basic purpose of accounting is to provide decision makers with information that is
useful in making economic decisions. These decisions are concerned with allocation and
use of scarce economic resources like money, land and labour. Financial information is
not only for business concerns but is necessary for all other types of organizations like
government, churches, non-governmental organizations. Managers of business concerns
will need to plan and control the operations of the enterprise. This can easily be done
 through the use of information provided by the accounting system in respect of
profitability, liquidity position and trend of earnings.

Objectives of Accounting
(i) Measurement or determination of wealth
a) Wealth = Net Worth
This is the difference between what you own (assets)
and what you owe (liabilities)
b) Changes in wealth over time
Wealth position at the beginning + gains (losses)
(ii) Measurement or determination of profits
Profit = Difference between revenues and expenses.
This is the transactions approach. It is also referred to as the income statement
approach
Profit = Changes in wealth over time
This is the residual approach. It is also referred to as the statement of financial
position approach.
Wealth = Assets – Liabilities

Net Worth

Owners’ Equity = Assets – Liabilities

OE = A – L
A = L + OE Fundamental Accounting Equation
ACCOUNTING AND BOOKKEEPING
Accounting is the whole process of recording, classifying, summarizing and analyzing business
transactions to help in decision making. It also includes design of efficient accounting systems,
conducting audits and development of forecasts.
Bookkeeping is that part of accounting relating to the recording of transactions. It is routine,
repetitive and probably the simplest part of accounting.
FORMS OF BUSINESS ORGANIZATION
Sole proprietorship. A business concern owned by one person. Usually the owner is the manager.
It is common for small retail stores, farms and professional practices. The owner is personally
liable for all debts incurred by the business. From an accounting viewpoint, however, the
business is an entity separate from the proprietor.
Partnership. A business concern owned by two or more persons but not more than twenty. It is
common for small businesses and professional practices. Partners and the business concern are
regarded as separate accounting wise while legally they are not regarded as separate. In the event
of liquidation the individual partners will be called upon to pay the partnership debts which are
in excess of the assets of the firm.
Company. It is a legal entity in itself and is distinct from its owners. It is therefore regarded as an
artificial person. The owners of a company are called shareholders and their ownership is
evidenced by share capital. The number of shares owned by an individual determines his/her
extent of ownership in the company. The shares are freely transferable in a public company
while in the private company transfer is restricted. The shareholders are only liable for the debts
of the company to the extent of amount unpaid on their shares in case the company becomes
insolvent.
FINANCIAL STATEMENTS
The preparation of the financial statements is not the first step in the accounting process but it is
a convenient point to begin the study of accounting. The financial statements are the means of
conveying to management and to interested parties a concise picture of the profitability and
financial position of the business.
1. Statement of Comprehensive Income
It shows whether a business achieved or failed to achieve its primary objective. The
primary objective is making a profit or net income. Net income is earned when revenues
are greater than expenses.
Revenues are inflows of cash or other properties received in exchange for goods and
services provided to customers.
Expenses are goods and services consumed in operating a business.
In presenting this statement we indicate the business entity, name of the statement and the
period covered by the statement.
 ABC Enterprises
Statement of Comprehensive Income
For year ended 31st December 2023
Revenues: sh. Sh.
Commissions earned 400,000
Property management fees 50,000
Total revenue 450,000
Operating expenses:
Salaries expense 170,000
Rent expense 56,000
Utilities expense 44,000
Telephone expense 38,000
Advertising expense 32,000
Total operating expenses 340,000
Net income 110,000

2. Statement of Financial Position

The statement of financial position shows the financial position of a business on a
specific date. It lists the assets, liabilities or debts and the equity of the owner or owners
business.
An asset is a property or property right, and an equity is a right, claim, or interest in an
asset or assets.
In presenting the statement we indicate the business entity, name of statement and date of
statement.

ABC Enterprises
Statement of Financial Position
As at 31st December 2023
Assets sh.
Cash 80,000
Office supplies 40,000
Prepaid rent 15,000
Office equipment 90,000
Total assets 225,000

Liabilities
Accounts payable 70,000

Owner’s Equity
Joan Makena, capital 155,000
Total liabilities and owner’s equity 225,000
The business entity concept or assumption
A business entity is an economic unit which enters into business transactions that must be
recorded, summarized, and reported. The entity is regarded as separate from its owner or
owners.

Assets
Assets are economic resources which are owned by a business and are expected to benefit
future operations. Assets may have definite physical form such as land, buildings,
machinery and merchandise. Some assets exist not in physical or tangible form, but in the
form of valuable legal claims or rights like amounts due from customers, investments in
government bonds and patent rights.

The cost principle

Assets such as land, buildings, merchandise and equipment are typical of the many
economic resources that will be used in producing income for the business. The
prevailing accounting view is that such assets should be recorded at their cost. This is
also called the historical cost principle.

The going concern assumption

A business entity is assumed to continue in its operations in the foreseeable future. In
other words it will operate indefinitely.
We therefore ignore market values of assets used in operations. Unless there is a sale the
market values cannot be objectively be determined.

The objectivity principle

Another reason for using cost rather than current market values in accounting for assets is
the need for a definite, factual basis for valuation. The cost for land, buildings and many
other assets purchased for cash can be definitely determined. Accountants use the term
objective to describe asset valuations that are factual and can be verified by independent
experts.

Monetary unit assumption

Accounting transactions are measured, recorded and reported in terms of money, in our
case the kenya shilling. The monetary unit is assumed to be stable.

Time period or periodicity assumption

We assume an indefinite life for most accounting entities. But accountants are asked to
measure operating progress and changes in economic position at relatively short time
intervals during this indefinite economic life. We therefore assume that the indefinite
economic life can be divided into artificial time periods like a month, quarter, half year
and one year.
Liabilities
Liabilities are debts. The liability arising from the purchase of goods or services on credit
is called an account payable and the person or company to whom the account payable is
owed is called a creditor.
The form of liability when money is borrowed is usually a note payable, a formal written
promise to pay a certain amount of money plus interest at a definite future time.

Owner’s equity
The owner’s equity in a business represents the resources invested by the owner. It is
equal to the total assets minus the liabilities. The equity of the owner is a residual claim
because the claims of the creditors legally come first. The owner’s equity in a business
comes from
1) Investment by the owner
2) Earnings from profitable operation of the business.

Decreases in owner’s equity are caused by

1) Withdrawal or drawings of cash or other assets by the owner
2) Losses from unprofitable operation of the business.

Effects of business transactions upon the statement of financial position

John Robert invested sh. 500,000 which was deposited in a bank account in the
name of the business, Robert Real Estate on 1st September 2023.

Sep 3 Purchased land suitable as a site for an office for sh. 200,000 and paid cash

Sep 5 Purchased from Mara Traders an office building for sh. 360,000. The terms
provided for cash payment of sh. 150,000 and the balance to be paid in 90 days

Sep 10 Sold to David Stores part of the land purchased on September 3 that was
unused at the same rate per foot as it was purchased for sh. 50,000. There was no
gain or loss. The total amount to be paid in 90 days.

Sep 14 Purchased on credit office equipment for sh. 25,000

Sep 20 Cash of sh.15,000 received from David Stores in partial settlement .

Sept 30 Paid sh. 120,000 to Mara Traders in partial settlement.

Effects of business transactions on the accounting