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Module 02 Notes

The document provides an overview of accounting information, its users, and the qualities of useful financial information, emphasizing the importance of financial statements for decision-making. It outlines the roles of various stakeholders such as owners, customers, suppliers, managers, lenders, and government agencies in utilizing accounting data. Additionally, it discusses the accounting equation, the structure of a balance sheet, and the establishment of the Institute of Certified Public Accountants of Kenya (ICPAK) and its functions.

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0% found this document useful (0 votes)
2 views8 pages

Module 02 Notes

The document provides an overview of accounting information, its users, and the qualities of useful financial information, emphasizing the importance of financial statements for decision-making. It outlines the roles of various stakeholders such as owners, customers, suppliers, managers, lenders, and government agencies in utilizing accounting data. Additionally, it discusses the accounting equation, the structure of a balance sheet, and the establishment of the Institute of Certified Public Accountants of Kenya (ICPAK) and its functions.

Uploaded by

frankndende96
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© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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INTRODUCTION TO ACCOUNTING (PART II)

USERS OF ACCOUNTING INFORMATION

Accounting information is produced in form of financial statement. These financial statements


provide information about an entity financial position, performance and changes in financial
position.

Financial position of a firm – what the resources the business has and how much belongs to the
owners and others.

The financial performance reflects how the business has performed, whether it has made profits
or losses.

Changes in financial positions determine whether the resources have increased or reduced. The
users of accounting information have an interest in the existence of the firm. Therefore the
information contained in the financial statements will affect the decision making process.

The following are some of the users of accounting information:

i. Owners:
They have invested in the business and examples of such owners include sole traders, partners
(partnerships) and shareholders (company). They would like to have information on the financial
performance, financial position and changes in financial position.

This information will enable them to assess how the managers of the business are performing
whether the business is profitable or not and whether to make drawings or put in additional
capital.

ii. Customers
Customers rely on the business for goods and services. They would like to know how the
business is performing and its financial position. This information would enable them to assess
whether they can rely on the firm for future supplies.

iii. Suppliers
They supply goods or services to the firm. The supplies are either for cash or credit. The
suppliers would like to have information on the financial performance and position so as to
assess whether the business would be able to pay up for the goods and services provided as and
when the payments fall due.

iv. Managers
The managers are involved in the day-to-day activities of the business. They would like to have
information on the financial position, performance and changes in financial position so as to
determine whether the business is operating as per the plans. In case the plan is not achieved then
the managers come up with appropriate measures (controls) to ensure that the set plans are met.

v. The Lenders
They have provided loans and others sources of capital to the business. Such lenders include
banks and other financial institutions. They would like to have information on the financial
performance and position of the business to assess whether the business is profitable enough to
pay the interest on loans and whether it has enough resources to pay back the principal amount
when it is due.

vi. The Government and its agencies


The Government is interested in the financial performance of the business to be able to assess the
tax to be collected in the case there are any profits made by the business. The other government
agencies are interested with the financial position and performance of the business to be able to
come with National Statistics. This statistics measure the average performance of the economy.

vii. The Financial Analyst and Advisors


Financial analyst and advisors interpret the financial information. Examples include stockbrokers
who advise investors on shares to buy in the stock market and other professional consultants like
accountants. They are interested with the financial position and performance of the firm so that
they can advise their clients on how much is the value their investment i.e. whether it is
profitable or not and what is the value. Others advisors would include the press who will then
pass the information to other relevant users.

viii. The Employees


They work for the business/entity. They would like to have information on the financial position
and performance so as to make decisions on their terms of employment. This information would
be important as they can use it to negotiate for better terms including salaries, training and other
benefits. They can also use it to assess whether the firm is financially sound and therefore their
jobs are secure.

ix. The Public


Institutions and other welfare associations and groups represent the public. They are interested
with the financial performance of the firm. This information will be important for them to assess
how socially responsible is the firm. This responsibility is in form the employment opportunities
the firm offers, charitable activities and the effect of firm’s activities on the environment.

QUALITIES OF USEFUL FINANCIAL INFORMATION


The five principal qualities of useful financial information are Understandability, relevance,
reliability and comparability.

1. Understandability: an essential quality of the information provided in the financial


statements is that it is readily understandable by users. For these reason users are
assumed to have a reasonable knowledge of business and economic activities and
accounting.
2. Relevance: information has the quality of being relevant when it influences the
economic decisions of users by helping them evaluate past, present or future events or
confirming or correcting their past evaluations. The relevance of information is affected
by its nature and materiality.
3. Reliability: information is useful when it is free from material error and bias and can be
depended upon by users to represent faithfully that which it purports to represent or could
reasonably be expected to represent. To be reliable then the information should:

a) Be represented faithfully,
b) Be accounted for and presented in accordance with their substance and economic reality and
not merely their legal form,
c) Be neutral i.e. free from bias,
d) Include some degree of caution especially where uncertainties surround some events and
transactions (prudence),
e) Be complete i.e. must be within the bounds of materiality and cost. An omission can cause
information to be false.
4. Comparability: users must be able to compare the financial statements of an enterprise
through time in order to identify trends in its financial position and performance. Users
must also be able to compare the financial statements of different accounting policies,
changes in the various policies and the effect of these changes in the accounts.
Compliance with accounting standards also helps achieve this comparability
5. Timely. If the accounting information is not availed to the deserving user at the time of
need, then it may as well be useless. For accounting information to be useful, it must be
presented to the party in need at the time of the need.

The Accounting Profession in Kenya


The Accountants Act Cap 531 (2008) establishes the Institute of Certified Public Accountants of
Kenya (ICPAK) and two boards, to be known as the Council of ICPAK and Kenya Accountants
and Secretaries National Examinations Board (KASNEB)

The following are the functions of ICPAK as outlined by the Act;

 To promote standards of professional competence and practice amongst members of the


institute.
 To promote research into the subjects of accountancy and finance, and related matters,
and the publication of books, periodicals, journals and articles in connection therewith;
 To promote the international recognition of the institute;
 To advise the Examinations board on matters relating to examination standards and
policies;
 To carry out any other functions prescribed for it under any of the provisions of the Act
or under any other written law; and
 To do anything incidental or conducive to the performance of any of the preceding
functions.
A council known as the Council of the institute governs the Institute, which consists of the
Chairman, nine members from the institute and one member appointed by the Minister of
finance.

The Act also outlines the following as the functions of KASNEB:


a) To prepare syllabuses for accountants’ and secretaries’ examinations, to make rules with
respect to examinations, to arrange and conduct examinations and issue certificates to
candidates who have satisfied examination requirements;
b) To promote recognition of its examinations in foreign countries; and
c) To do anything incidental or conducive to the performance of any preceding functions.
d) Among others

THE ACCOUNTING EQUATION


A business owns properties. These properties are called assets. The assets are the business resources that
enable it to trade and carry out trading. They are financed or funded by the owners of the business who
put in funds. These funds, including assets that the owner may put is called capital. Other persons who
are not owners of the firm may also finance assets. Funds from these sources are called liabilities. The
total assets must be equal to the total funding i.e. both from owners and non-owners. This is expressed
inform of accounting equation which is stated as follows:

ASSETS = LIABILITIES + CAPITAL

Each item in this equation is briefly explained below.

Assets:
An asset is a resource controlled by a business entity/firm as a result of past events for which economic
benefits are expected to flow to the firm. An example is if a business sells goods on credit then it has an
asset called a debtor. The past event is the sale on credit and the resource is a debtor. This debtor is
expected to pay so that economic benefits will flow towards the firm i.e. in form of cash once the
customers pays.

Assets are classified into two main types:


i) Non-current assets
ii) Current assets.

Noncurrent assets are acquired by the business to assist in earning revenues and not for resale. They are
normally expected to be in business for a period of more than one year.
Major examples include:
 Land and buildings
 Plant and machinery
 Fixtures, furniture, fittings and equipment
 Motor vehicles
Current assets are not expected to last for more than one year. They are in most cases directly related to
the trading activities of the firm. Examples include:
 Stock of goods – for purpose of selling.
 Trade debtors/accounts receivables – owe the business amounts as a resort of trading.
 Other debtors – owe the firm amounts other than for trading.
 Cash at bank.
 Cash in hand.
 Prepaid expenses

Liabilities:
These are obligations of a business as a result of past events settlement of which is expected to result to
an economic outflow of amounts from the firm. An example is when a business buys goods on credit,
then the firm has a liability called creditor. The past event is the credit purchase and the liability being the
creditor the firm will pay cash to the creditor and therefore there is an out flow of cash from the business.

Liabilities are also classified into two main classes.

i) Non-current liabilities (or long term liabilities)


ii) Current liabilities.

Non-current liabilities are expected to last or be paid after one year. This includes long-term loans
from banks or other financial institutions. Current liabilities last for a period of less than one year and
therefore will be paid within one year. Major examples:
1. Trade creditors/or accounts payables – owed amounts as a result of business buying goods on
credit.
2. Other creditors - owed amounts for services supplied to the firm other than goods.
3. Bank overdraft - amounts advanced by the bank for a short-term period.
4. Prepaid incomes

Capital:
This is the residual amount on the owner’s interest in the firm after deducting liabilities from the assets.
The Accounting equation can be expressed in a simple report called the Balance Sheet. The basic format
is as follows:

The balance sheet is presented using the Vertical format

Name of entity
Balance sheet as at XXX.

Non-Current Assets Sh Sh Sh
Land & Buildings xx
Plant & Machinery xx
Fixtures, furniture & fittings xx
Motors vehicles xx
xx
Current Assets
Stocks/inventories xx
Debtors/ trade receivables xx
Cash at bank xx
Cash in hand xx

Current Liabilities
Bank Overdraft xx
Creditors/trade payables xx (xx)
Net Current Assets/Liabilities xx
Net assets xx

Capital xx
Non-Current Liabilities
Loan (from bank or other sources) xx
xx

Please pay attention to the format. The Non-Current assets are listed in order of permanence as
shown i.e. from Land and Buildings to motor vehicles. The Current Assets are listed in order of
liquidity i.e. which asset is far from being converted into cash. Example, stock is not yet sold,
(i.e. not yet realised yet) then when it is sold we either get cash or a debtor (if sold on credit).
When the debtor pays then the debtor may pay by cheque (cash has to be banked) or cash.
The Current Liabilities are listed in order of payment i.e. which is due for payment first. Bank overdraft
is payable on demand by the bank, then followed by creditors. Note that in the vertical format, current
liabilities are deducted from current assets to give net current assets. This is added to Non-Current assets,
which give us net assets. Net assets should be the same as the total of Capital and Non-Current Liabilities.

Exercise one

Onyango has a business that has been trading for some time. You are given the following
information as at 31st December 2019
‘000’
Land and Buildings 11,000
Furniture & Fittings 5,500
Motor Vehicles 5,800
Stocks 8,500
Debtors 5,600
Bank 1,500
Cash 400
Creditors 2,500
Capital 30,800
Loan 5,000

Required: prepare a statement of financial position (Balance Sheet) as at 31 December 2019

Exercise two
Kamau sets up a new business. Before he actually sells anything, he buys motor vehicles of
3,000,000, premises of 7,000,000, stock of goods 2,000,000 which he still owes 800,000 in
respect of them. He borrows 4,000,000 from Evans. After the events described and before
trading starts, he has 300,000 cash and 600,000 in the bank.

Required: Calculate the amount of his capital and prepare the statement of financial position
(balance sheet)

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