LECTURE NOTE ONE

Study Session 1: Nature and Purpose of Accounting

Introduction
Accounting is a service activity. Its function is to provide quantitative information,
primarily financial in nature, about economic entities that is intended to be useful in
making economic decisions, in making reasoned choices among alternative courses of
action. In this study session, you will be introduced to the meaning of accounting, the
difference between book-keeping and accounting, the purpose of accounting, the users
and uses of accounting information.

Learning Outcomes for Study Session 1

On completion of this study session, you should be able to:

1.1 Explain the Meaning of Accounting

1.2 Differentiate between Book-keeping and Accounting
1.3 Describe the Purpose of Accounting
1.4 Identify the Users and uses of accounting information

1.1 Meaning and Definition of Accounting

Accounting is concerned with the recording, classifying, summarizing and communicating
the financial information of an entity to interested parties and interpreting in order to aid
business decisions. Businesses use accounting to keep their financial information organized
which helps them in making sense of their financial data and also keeps them compliant of
financial regulations.
Although, accounting has often been viewed as an important tool of business, today every
organization uses accounting in order to organize and make meaning of their financial data
and better manage such entities. For this reason the use of accounting transcends businesses,
governmental institutions, universities, societies etc.

Meaning and Definition of Accounting

Accounting has been described by many as the “language of business”. Accounting provides
the mechanisms for the identification, measurement and recording of economic information
of an entity.

Box 1.1: Definition of Accounting

Accounting can be defined as the science of recording, classifying, summarizing transactions,
reporting and analyzing financial data of an entity’s result of operations during a particular
period, and the financial position as the end of the period to the users of the financial
statements for decision making.
(Personal construction)

Accounting is the process of recording the financial transactions of a business. The

accounting process includes summarizing, analyzing, and reporting these transactions to
oversight agencies, regulators, and tax collection entities and other users of accounting

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information. The financial statements used in accounting are a concise summary of financial
transactions over an accounting period, summarizing a company's operations, financial
position, and cash flows.
Accounting as an information system is the process of identifying, measuring and
communicating the economic information of an organization to its users who need the
information for decision making. It identifies transactions and events of a specific entity.
The definition of accounting states that it includes recording, summarizing, reporting and
analyzing financial data. Let’s try and explain the key terms involved in the definition to
enable use understand the task and activities involved in accounting better and what it really
means:
Recording - The primary function of accounting is to make records of all the transactions that
the firm enters into. Recognizing what qualifies as a transaction and making a record of the
same is called bookkeeping. Bookkeeping is narrower in scope than accounting and concerns
only the recording part. For the purpose of recording, accountants maintain a set of books.
Their procedures are very systematic. Nowadays, computers have been deployed to
automatically account for transactions as they happen.
Summarizing- Recording for transactions creates raw data. Pages and pages of raw data are of
little use to an organization for decision making. For this reason, accountants classify data
into categories. These categories are defined in the chart of accounts. As and when
transactions occur, two things happen, firstly an individual record is made and secondly the
summary record is updated.
For instance a sale to Mr. John for N1,000 would appear as:
Sale to Mr. John for N1,000
Increases the total sales (summary) by 1,000
Reporting- Management is answerable to the investors about the company’s state of affairs.
The owners need to be periodically updated about the operations that are being financed with
their money. For this reason, there are periodic reports which are sent to them. Usually the
frequency of these reports is quarterly and there is one annual report which summarizes the
performance of all four quarters. Reporting is usually done in the form of financial
statements. These financial statements are regulated by government bodies to ensure that
there is no misleading financial reporting.
Analyzing- Lastly, accounting entails conducting an analysis of the results. After results have
been summarized and reported, meaningful conclusions need to be drawn. Management must
find out its positive and negative points. Accounting helps in doing so by means of
comparison. It is common practice to compare profits, cash, sales, assets, etc of one period
with another to analyze the performance of the business.

1.1.1 Accounting as a field of Study and Profession

Accounting is also a field of study and profession dedicated to carrying out those tasks. The
financial statements that summarize a large company's operations, financial position, and
cash flows over a particular period are concise and consolidated reports based on thousands
of individual financial transactions. As a result, all accounting designations are the
culmination of years of study and rigorous examinations combined with a minimum number
of years of practical accounting experience.
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While basic accounting functions can be handled by a bookkeeper, advanced accounting is
typically handled by qualified accountants who possess designations such as Chartered
Accountant (CA) and Certified National Accountants (CNA) in Nigeria, Certified Public
Accountant (CPA) or Certified Management Accountant (CMA) in the United States and
Certified Chartered Accountant (CCA) in UK. In Canada, the designations are Chartered
Accountant (CA), Certified General Accountant (CGA), and Certified Management
Accountant (CMA).

1.1.2 Components of Accounting

Accounting consists of two main branches/parts- namely: financial accounting and

management accounting

a. Financial Accounting: This branch deals with the preparation of financial statements
for the use of outsiders like creditors, banks, government etc. The principal purpose of
financial accounting is the show the profit or loss made by the organization and its
financial position Book –keeping is an important component of financial accounting
without which the purpose of financial accounting can be achieved

Book-keeping involves the recording of financial transactions (e.g. purchase, sales,

and expenses) in a systematic way as they occur in the appropriate books of accounts
which are then summarized and presented in the form of financial statements which
show the overall financial position of the business. Book-keeping is carried out based
on the double entry system.

Book-keeping helps businesses organize their financial data which facilitates the
effective management of the business by providing key information such as:

(i) How much capital is invested by the owners in the business?

(ii) How much does the business owe the employees, suppliers, banks, tax
authorities etc?
(iii) How much does each customer owe the business?
(iv) How profitable is the business?

Bookkeeping is the backbone of an accounting system and forms the basis of analysis
in management accounting.
b. Management accounting, also known as managerial accounting, provides
information to management for analysis, decision making, planning and control of the
business. For example, information relating to investment decisions, budgeting and
performance measurement. It is meant to provide information of internal use by the
management. Cost accounting provides the foundation for a functional management
accounting system. Cost accounting deals with the ascertainment of cost of products
and services to assist management in controlling its costs.

1.2 Book-Keeping and Accounting

All activities of entities whether they are business activities or non-business activities
including organizations like schools universities , hospitals, libraries, clubs, societies ,
political parties which require money and other economic resources, accounting is required to
account for these resources. In other words, wherever money is involved, accounting is
required to account for it.

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However, Accounting involves the process of identifying, measuring, recording, and
communicating economic information about an organization or other entity, in order to
permit informed judgments by users of the information. On the other hand, Book-keeping
encompasses the record-keeping aspect of accounting.

1.2.1 Meaning and Definition of Book- Keeping

Book- keeping includes recording of journal, posting in ledgers and balancing of accounts.
All the records before the preparation of trial balance are the whole subject matter of book-
keeping. Thus, book- keeping may be defined as the science and art of recording transactions
in money or money’s worth so accurately and systematically, in a certain set of books,
regularly that the true state of businessman’s affairs can be correctly ascertained.

Here it is important to note that only those transactions of the business that can be expressed
in monetary terms are recorded in the books of accounts. Book- keeping can also be defined
as the science and art of correctly recording in books of account all those business
transactions that result in the transfer of money or money’s worth.

Box 1.2: Definition of Book-keeping

Book- keeping is the art and science of recording transactions in money or money’s worth so
accurately and systematically, in a certain set of books, regularly that the true state of
businessman’s affairs can be correctly ascertained.

1.2.2. Objectives of Book- keeping

The following are the objectives of book keeping:

1 Book- keeping provides a permanent record of each transaction.

2 Soundness of a firm can be assessed from the records of assets and abilities on a
particular date.
3 Entries related to incomes and expenditures of a concern facilitate to know the profit
and loss for a given period.
4 It enables to prepare a list of customers and suppliers to ascertain the amount to be
received or paid.
5 It is a method that gives opportunities to review the business policies in the light of
the past records.
6 Amendment of business laws, provision of licenses, assessment of taxes etc. are based
on records.

1.2.3 Distinctions between Book-Keeping and Accounting

The differences between book-keeping and accounting can be summarized in a tabular form
as shown in Table 1.1 below:

Table 1.1: Distinction between Book-Keeping and Accounting

Basis of difference Book keeping Accounting

Transactions Recording of transactions in To examine these recorded

books of original entry transactions in order to find out
their accuracy

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 Posting To make posting in ledger To examine this posting in order
to
ascertain its accuracy

Total and Balance To make total of the amount in To prepare trial balance with the
journal and account of ledger. To help of balances of ledger
ascertain balance in all the accounts
accounts.

Income statement Preparation of trading, Profit & Preparation of trading, profits

and Balance sheet loss account and balance sheet is and loss account and balance
not book keeping sheet is included in it

Rectification of These are not included in book- These are included in

errors keeping Accounting

Special skill and It does not require any special It requires special skill and
knowledge skill and knowledge as in knowledge
advanced countries this work is
done by machines/computers

Liability A book-keeper is not liable for An accountant is liable for the

accountancy work work of bookkeeper

1.3 Purpose of Accounting

Accounting has a wide range of uses. Although the objective of accounting may differ from
business to business depending upon their specific requirements. However, the following are
the general objectives of accounting.

i. Record Keeping- This is otherwise referred to as book-keeping function of

accounting. The book-keeping aspect of accounting provides organizations with
the systems of recording, classifying and summarizing their financial transactions
in order aid the presentation their financial statements Organizations need to have
a reliable and systematic way of recording financial information. Accounting is
necessary to ensure that those running the business have a reliable record of
financial transactions.
ii. Legal Requirement and Representation- Accounting helps organizations to
determine their financial rights and obligations. Without proper accounting, it
would be very difficult for a business to account for and establish the rights and
obligations of the various stakeholders of a business in terms of capital, asset,
liabilities etc. Accounting is therefore necessary for a business to fulfill its legal
obligations and asserting its own legal rights. Entities such as companies,
societies, and trusts are compulsorily required to maintain accounts as required by
the law governing their operations such as the Companies and Allied Matters Act,
Societies Act, and Public Trust Act etc. Maintenance of accounts is also
compulsory under the Sales Tax Act and Income Tax Act.
Accounting also aids courts in administering justice especially among parties in asset
sharing even when there is no dispute the financial statements still remains a useful

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 tool. Maintaining accounting records and preparing financial statements is also often a
legal responsibility for businesses above a certain size.

iii. Performance Analysis- Accounting is used to generate the financial statements

which can be used to ascertain the results of operations of the business over a
specified period. Business owners can assess the performance over the business.
This can be achieved based on the information contained in the statement of profit
or loss account or income and expenditure account by matching items of revenue
and expenditure over the same period.

iv. Ascertain the financial position of the business - Accounting information is

summarized to produce financial statements. Financial Statements provide an
overview of the financial activities of a business during a period (e.g. cash flow,
income and expenses during the year) as well as information about its financial
position on a specific date (e.g. amount of cash, inventory, assets, indebtedness
and capital at the end of the year). In addition to profit, a businessman must know
his financial position i.e., availability of cash, position of assets and liabilities etc.
This helps the businessman to know his financial strength. Financial statements
are barometers of health of a business entity.
v. Portray the liquidity position: Financial reporting should provide information
about how an enterprise obtains and spends cash, about its borrowing and
repayment of borrowing, about its capital transactions. It provided information
about the structure of the firm’s assets and implications on the liquidity and
solvency of the business.
vi. Protect business assets: Accounting provides up to date information about the
various assets that the firm possesses and the liabilities the firm owes. This makes
it difficult for people to make false claim over the business assets.
vii. Planning and Control- Accounting helps organizations to plan their finances by
developing budgets and forecasts. Variance analysis provides a mechanism for the
monitoring of expenses incurred by organizations by comparison with the
budgeted expenditure. This process helps organizations in planning their finances
ahead and controlling any deviations from the budget.
viii. Decision Making- Accounting provides a basis for managerial decisions. Such
decisions may include- investment appraisal, make or buy decisions The analysis
of income statement and statement of financial position of the business can guide
investment decisions (e.g. whether they should invest more in the business,
diversify or dispose their investment).

1.4 Users and Uses of Accounting Information

1.4.1 Importance of Accounting

Below are some of the users and the importance of accounting to their respective users:

Owners: The owners provide funds or capital for the organization. They possess curiosity in
knowing whether the business is being conducted on sound lines or not and whether the
capital is being employed properly or not. Owners, being businessmen, always keep an eye
on the returns from the investment. Comparing the accounts of various years helps in getting
good pieces of information.

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Management: The management of the business is greatly interested in knowing the position
of the firm. The accounts are the basis, the management can study the merits and demerits of
the business activity. Thus, the management is interested in financial accounting to find
whether the business carried on is profitable or not. The financial accounting is the “eyes and
ears of management and facilitates in drawing future course of action, further expansion etc.”
Creditors: Creditors are the persons who supply goods on credit, or bankers or lenders of
money. It is usual that these groups are interested to know the financial soundness before
granting credit. The progress and prosperity of the firm, two which credits are extended, are
largely watched by creditors from the point of view of security and further credit. Profit and
Loss Account and Balance Sheet are nerve centres to know the soundness of the firm.
Employees: Payment of bonus depends upon the size of profit earned by the firm. The more
important point is that the workers expect regular income for the bread. The demand for wage
rise, bonus, better working conditions etc. depend upon the profitability of the firm and in
turn depends upon financial position. For these reasons, this group is interested in accounting.
Investors: The prospective investors, who want to invest their money in a firm, of course
wish to see the progress and prosperity of the firm, before investing their amount, by going
through the financial statements of the firm. This is to safeguard the investment. For this, this
group is eager to go through the accounting which enables them to know the safety of
investment.
Government: Government keeps a close watch on the firms which yield good amount of
profits. The state and central Governments are interested in the financial statements to know
the earnings for the purpose of taxation. To compile national accounting is essential.
Consumers: These groups are interested in getting the goods at reduced price. Therefore,
they wish to know the establishment of a proper accounting control, which in turn will reduce
to cost of production, in turn less price to be paid by the consumers. Researchers are also
interested in accounting for interpretation.
Research Scholars: Accounting information, being a mirror of the financial performance of
a business organization, is of immense value to the research scholar who wants to make a
study into 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 share-holders funds
which is available in the accounting record maintained by the firm.

1.4.2 Functions of Accounting

Below are some of the functions of accounting:

 Record keeping function

 Managerial function
 Legal requirement function
 Language of Business

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Record Keeping Function: The primary function of accounting relates to recording,
classification and summary of financial transactions-journalisation, posting, and preparation
of final statements. These facilitate to know operating results and financial positions.
The purpose of this function is to report regularly to the interested parties by means of
financial statements. Thus, accounting performs historical function i.e., attention on the past
performance of a business; and this facilitates decision making programme for future
activities.
Managerial Function: Decision making programme is greatly assisted by accounting. The
managerial function and decision making programme, without accounting, may mislead. The
day-to-day operations are compared with some predetermined standard. The variations of
actual operations with pre-determined standards and their analysis are possible only with the
help of accounting.
Legal Requirement function: Auditing is compulsory in case of registered firms. Auditing
is not possible without accounting. Thus, accounting becomes compulsory to comply with
legal requirements. Accounting is a base and with its help, various returns, documents,
statements etc., are prepared.
Language of Business: Accounting is the language of business. Various transactions are
communicated through accounting. There are many parties-owners, creditors, government,
employees etc., who are interested in knowing the results of the firm and this can be
communicated only through accounting. The accounting shows a real and true position of the
firm or the business.

1.4.3 Advantages and Disadvantages of Accounting

Below are the advantages and disadvantages of accounting:

Advantages of Accounting
The following are the advantages of accounting to a business:

1 It helps in having complete record of business transactions.

2 It gives information about the profit or loss made by the business at the close of a year
and its financial conditions.
3 It provides useful information for making economic decisions.
4 It facilitates comparative study of current year’s profit, sales, expenses etc., with those
of the previous years.
5 It supplies information useful in judging the management’s ability to utilize enterprise
resources effectively in achieving primary enterprise goals.
6 It provides users with factual and interpretive information about transactions and
other events which are useful for predicting, comparing and evaluation the
enterprise’s earning power.
7 It helps in complying with certain legal formalities like filing of income tax and sales-
tax returns.

1.4.4 Limitations of Accounting

The following are limitations or disadvantages of accounting;

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 1. Accounting is historical in nature: It does not reflect the current financial position or
worth of a business.
2. Transactions of non-monetary mature do not find place in accounting. Accounting is
limited to monetary transactions only. Thus, it excludes qualitative elements like
management, reputation, employee morale, labour strike etc.
3. Facts recorded in financial statements are greatly influenced by accounting
conventions and personal judgments of the Accountant or Management.
4. Accounting principles are not static or unchanging-alternative accounting procedures
are often equally acceptable. Therefore, accounting statements do not always present
comparable data.
5. Cost concept is found in accounting. Price changes are not considered. Money value
is bound to change often from time to time. This is a strong limitation of accounting.
6. Accounting statements do not show the impact of inflation.
7. The accounting statements do not reflect those increases in net asset values that are
not considered realizable.

Summary of Study Session 1

In this study session, you have learned the following:

1. Accounting is concerned with the recording, classifying, summarizing and

communicating the financial information of an entity to interested parties and
interpreting in order to aid business decisions.
2. Book- keeping includes recording of journal, posting in ledgers and balancing of
accounts. All the records before the preparation of trial balance are the whole subject
matter of book- keeping.
3. The differences between book-keeping and accounting.

4. Accounting consists of two main branches/parts- namely: financial accounting and

management accounting.

5. Accounting has a wide range of uses. Although the objective of accounting may differ
from business to business depending upon their specific requirements.
6. There are various functions of accounting in the modern day business environment
which include language of business among others.

Glossary of Terms

Accountant is a professional who performs accounting functions such as audits or financial

statement analysis.

Accounting information is a data about a business entity’s transactions. They are the data
that arises from business transactions.
Internal users refer to the people in the organization producing the accounting reports.
External users are the people, institutions and entities outside the organization’s boundaries
that use the information for the purpose of decision-making.

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