Introduction to the principle of accounting

Defination of terms
Accounting
_ it is the process of classifying, summarizing and interpreting the financial
statements in a manner understandable for all
_ is a process of gathering, measuring, Identify and interpreting financial information
so as to permit the users of the information to make decisions
Accounts_ refers to the records of business transactions
Bookkeeping
_ is the systematic recording of business transactions in the books of accounts
Business or enterprise
_ refers to any entity registered or unregistered that undertakes commercial activities
either for profit making or not for profit making or not
Assets_ Is what business owns
_Is the belongings of a business used to generate income
Classification of assets
Current assets and non_ current assets
Current assets
_ are the resources that stay in the business for a short period of time usually less than
one year eg inventory, trade receivables, prepayments, bank and cash in hand
Non_ current assets
_ are resources that stay in the business for a long period of time usually more than
one year eg land, building, machinery, equipment, furniture and motor vehicles
Liabilities
_are financial obligations of a business
_ are what a business owes
Classification of liabilities
Current liabilities and non_current liabilities
Current liabilities
_ are short term financial obligations of a business and they have a short repayment
period which is less than one year eg creditors, bank overdraft, accruals
Non_ current liabilities
_ are long term financial obligations of a business and they have a long repayment
period which is more than one year eg long term loan and debentures
Capital
_is the wealth or resources used to start a business
_ is the money used to to start a business
_ capital can be in form of assets, money or human capital
Drawings
_ is money or goods taken by the owner from the business for personal use or private
use
_ drawings reduce the owner's capital
Purchases _ are goods bought for resale
Sales_ are goods sold to customers by the business
Expenses _ are bills paid for
Inventory_ unsold goods
Net profit _ is the amount by which the total incomes are greater than the total
expenses
Net loss_ this is the amount by which the expenses exceed the incomes of the
business

Types of business activities and organization

Business activities
Major activities done by the business are manufacturing and trading
Trading_ refers to buying and selling of goods and provision of services normally for
a gain
Manufacturing _ is the production or making of goods
Business organization
Profit making and not for profit making business organizations
Sole proprietor or sole trader
_is owned by one person who is normally the manager
_ the trader contribute capital alone
_They are formed to make profit
_ less legal formalities are required of them to start operating

Advantages of sole proprietor

There are few legal formalities required to set up a sole proprietor business
_ the owner enjoys profits alone
_ There is independence in decision making
_ privacy _ no published accounts
_ the owner has personal contract with his customers
_ fewer overhead costs
_ little capital is needed to start a business
_ the business is easy to start and operate
_ can open for long hours in order to increase profits

Disadvantages of sole proprietor

_ poor decisions due to lack of consultations
_ limited capital
_ responsible for the debts of the business
_ lack of specialist skills as the proprietor may employ less qualified people
_ suffers all losses and bear all the risks
_ lack continuity after the death of the owner
_ lacks collateral security which prohibits borrowing loans from banks

Partnerships
_ is formed between two and twenty people who agree to engage in a business activity
for their joint benefit
_ is a business which is formed by 2_20 people who puts their resources together with
the view of profit making
_is governed by a document called a partnership deed of agreement
Partnership deed contains
_ all what partners agreed as legally binding
The amount of capital to be contributed by each partner
The profit or loss sharing ratios
Salary if any entitled to partners

Advantages
_ more capital is raised
_ more ideas are contributed
_ less legal formalities
_ easy to run and control
_ partners may share duties and responsibilities
_ losses are shared amongst partners

Disadvantages
Disputes may lead to desolution of the business
_ lack enough capital for business expansion
_ active partners suffers from unlimited liability
_ poor decision making by one partner binds all partners
_ lacks continuity if the key partner is ill or dead
_ less capital limits borrowing loans and overdrafts from banks and other financial
institutions

Limited liability companies

_ is a separate legal entity which is distinguished from its owners
_ a limited company can sue or be sued in its own name for any wrong doing

Private limited company

_ is formed by one shareholder upto a maximum of fifty shareholders

Importance of accounting information

_ used for measuring and evaluating performance of the business
_ used for comparisons with other business
_ used to measure the profitability of the business
_ provide best information on how worthwhile it is to invest in the business
_ provide information on how the business is using its resources to generate profits
_ used to assess whether the business is capable of borrowing
_ tax computations by government authorities
_ enable period of comparison

Users of accounting information

Investors _ refers to people who are willing to invest in the operations of the
company. They use accounting information so as to decide whether to invest their
money or not
Managers _ wants to know how well the business is progressing financially so that
they make their decisions effectively leading to the success of the business
Suppliers or trade payables _ want to access the credit worthiness of a business so as
to decide whether to grant goods on credit or not
Tax authority _ needs to verify the taxable income or tax refundable to the firm. Tax
authority is a government firm which is responsible for collect revenue on behalf of
the government through taxes and fines
Financial institutions _ want to know whether to lend or not to lend some money to
the firm eg banks
Prospective buyers _ when the owner wants to sell the business, the buyer use
financial information so as to ascertain whether to buy the business or not

2 )The accounting cyle

_ is the sequence of accounting stages in which accounting information pass through
systematically ( in a chronological order)
_ it is used to record, classify and summarise accounting information.
Stages of the accounting cycle
Transactions _ source document _ subsidiary books_ ledger_ trial balance _ income
statement _ statement of financial position
Transaction _ is an activity which involving the exchange of money

Subsidiary books
_ these are the books of original or prime entry in which transactions are first
recorded.

Trial balance
_ is a statement that contains a list of debit and credit balances that are extracted from
ledger accounts on a specific date

Ledger
Is the main book of accounts in which entries from the journals are posted and
summarised

Final accounts
_ are the end of year financial statements prepared to ascertain whether the business
made profit or loss and to see it's financial position

Data processing
Data
_ refers to raw facts , figures collected to be sorted
Data processing
_ is a process of converting and manipulating raw data into meaningful and usable
information
Data collection
_ involves the initial stages of gathering of data needed for processing
Data processing cycle
Manual data processing cycle
Input
_ is the first stage of the cycle where facts and figures are captured and collected
_ at this stage facts about business transactions are gathered from source documents

Advantages of manual methods

_ the system is easy and simple to set up
_ less risk of data loss
_ the process is very easy and simplified
_ it is easy to trace and locate errors

Disadvantages of manual methods

_ time consuming and tiresome
_ high chances of error
_ requires a lot of labour ( labour intensive)
_ very slow
_ poor retrieval capacity

Electronic methods
_ make use of electronic device called a computer
Computer_ is an electronic device that is programmed to accept data input (fed,
manipulate) and process data, produce and stores the output in various forms.

Functions of a computer
_Keyboard, mouse, scanner, barcode reader, joystick (and sceen) are used to enter or
feed the data into the computer
_ data processing that is the manipulation of raw data into meaningful information is
done by the central processing unit (CPU)
_ the processed data or meaningful information called output is given out by devices
such as the monitor, printer and speaker.
_ accounting packages (software) _ Pastel and Excel, QuickBooks

Subsidiary books
Cash book
Purchases journal/ purchases day book
Sales journal / sales daybook
Purchases returns journal/ returns outwards journal
Sales returns journal/ return inwards journal
Petty cashbook

Cash book _ is a subsidiary book where all transactions made by cash or cheque, be it
receipts or payments are recorded
A cashbook is botha cash account and a bank account
Purchases day book is a subsidiary book where all goods bought for resale are
recorded
Sales journal is a subsidiary book where all goods sold to customers on credit are
recorded
Sales returns is for goods returned by customers back into the business
Purchases returns is for goods returned by the business to suppliers
Invoice is a source document used when goods are bought or sold on credit
Debit note is a document sent by the business to the suppliers with the details of
goods being returned by the business
Credit note is a document sent to the customer by the business after agreeing to take
the goods returned into the business by customers

Sales journal
Records only goods sold to customers on credit
Records credit sales
Source document _ sales invoice
Making entries in the sales day book
From the copy of the sales invoice, the seller enters up the transaction in the sales day
book
This book is merely a list of details relating to each credit sale

Format of a sales day book

Sales journal
Date Particular/details Sales invoice Folio Amount
number DR CR

Name of the customer SL XX

Transferred to sales a/c GL XX

Posting credit sales to the sales ledger

The credit sales are now posted, one by one to the debit side of each customer 's a/c in
the sales ledger
At the end of each period the total of the credit sales is posted to the credit of the sales
a/c in the general ledger

The purchases day book

Records all goods bought for resale on credit
Purchases invoice is a source document used when goods are bought on credit
Format of a purchases journal
Date Particulars Purchases invoice number Folio Amount
DR CR

Name of the supplier PL xx

31 Transferred to purchases a/c GL Xx

Posting credit Purchases to the purchase ledger

The credit Purchases are posted one by one to the credit of each supplier 's a/c in the
purchase ledger
At the end of each period the total of the credit purchases is posted to the debit of the
purchases a/c in the general ledger

Sales returns journal

Is for goods returned by customers back into the business
Source document used _ credit note
Credit note is a document sent to the customer by the business after agreeing to take
the goods returned into the business by customers
Sales returns journal Is a book of original entry in which goods once sold to
customers on credit but returned for various reasons are recorded

Reasons why customers may return goods

Wrong colour, type, size
Damaged goods
Soiled goods
The customer bought more than was needed
The customer found goods to be difficult to use
Format of a sales return journal

Date Details Credit note number Folio Amount

DR CR

Name of the customer SL xx

Transferred to sales return GL xx

Posting the items

Sales ledger_ credit the amount of credit notes, one by one to the accounts of the
customers in the ledger
General ledger_ at the end of the period the total of the returns inwards day book is
posted to the debit of the returns inwards account
The total of all the returns inwards is transferred to the debit side of the returns
inwards account in the general ledger
The individual entries will be posted to the individual accounts of the customers in the
sales ledger
These entries will be posted as credits, reducing the amount owed to the business by
customers

Puchases returns journal

Is for goods returned by the business to suppliers
Source document used _ debit note
Debit note is a document sent by the business to the suppliers with the details of
goods being returned by the business
Reasons why the business may return goods to their suppliers
Damaged goods

Format of a purchases returns journal

Date Particular Debit note number Folio Amount
DR CR

Name of the supplier PL xx

Transferred to purchases returns a/c GL xx

Posting the items

The total of all the returns outwards is posted to the credit side of the returns outwards
account in the general ledger
The entries will be posted to the personal accounts of the suppliers in the
purchasesledger. The entries will be posted as debits, reducing the amount owed to
the suppliers by the business

Cash book
is a subsidiary book in which only transactions made by cash or cheque are recorded
be it receipts or payments