fUNDAMENTALS OF Accounting-I

JIMMA UNIVERSITY
DEPARTMENT OF ACCOUNTING AND FINANCE
FUNDAMENTALS OF ACCOUNTING
INSTRUCTOR : HIRKO TEFERI
 CHAPTER ONE
INTRODUCTION TO ACCOUNTING AND BUSINESS

 Learning Objectives
 Define Accounting
 Explain nature of a business
 Describe accounting as an information system.
 The role of accounting in business
 Explain the concepts of business transactions.
 Explain the overview of International Financial Reporting Standards (IFRS).
 Explain the overview of financial reporting requirements in Ethiopia and
AABE.
 Analyze and Record business transactions.
 Identify the Accounting equation and its basic elements.
 Prepare Financial statements for sole proprietorship.
 What is accounting?

 a process of identifying, measuring, recording and

communicating economic events of an organization
(business or non-business) to interested users of the
information.
 An information system is the collecting, processing, and
reporting of information to decision makers.
 Cont…d
4

1. identifying – involves selecting those events that are

considered evidence of economic activity relevant to a
particular organization.
2. Measuring- measuring economic events in terms of
money( birr or cents)
3. Recording- consists of keeping a chronological diary of
measured events in an orderly and systematic manner
4. Communicating- The information is communicated
through the preparation and distribution of accounting
reports, the most common of which are called financial
statements.
 Why accounting is said to be language of business?
5

 Because the business are communicated to others

through accounting information, which has to be
systematically recorded and presented.
 accounting plays an important role in the decision

making process of business entities

 BOOKKEEPING VERSUS ACCOUNTING
6

 Bookkeeping is the process of recording business

activities, and keeping the records.
 It is the record- making phase of accounting.
 Accounting includes bookkeeping.
 Types of businesses
7

 There are three different types of businesses:-

I. Service businesses provide services rather than
products to customers.
II. Merchandising businesses sell products they
purchase from other businesses to customers.
III. Manufacturing businesses change basic inputs into
products (FG) that are sold to individual customers
 Form of business organizations
8
There are three basic forms of business organizations:
i. Sole Proprietorships
 It is a business owned by one person and

 usually managed by the owner.

 Its advantage is cost information: easy and low cost of organizing.

 Disadvantage : the financial resource is limited that mean unlimited

liability all business and personal wealth are subject to creditor.

 Usually only a limited investment is required to begin operations.

 Is a separate entity for accounting purposes (Business entity

Concept)
 but it is not a separate legal entity from the owners.

 The owner will be held personally responsible for the debts and

actions of the business.

 ii. Partnerships
9

 It has more than one owner.

 A partnership is not a legal entity separate from the owners
 but an association that brings together the talents and
resources of two or more people.
 The owners of a partnership are known as partners.
 Its advantage is more financial and resources
 disadvantage is unlimited liability, management is
difficult and lack of continuity.
 The partners share the profits and losses of the partnership
according to an agreed –on formula
 iii. Corporations
10
 Association of individuals created by law or legal person.
 A business organized as a separate legal entity with ownership
divided into transferable units of capital is called a corporation.
 The owners of a corporation are called stockholders or
shareholders.
 corporation is a separate legal entity (the owners (stockholders)
are not personally liable for the debts of the corporation).
 Advantage is the ability too obtain large amount of resource
 disadvantage of corporation is double taxation and charter
restriction.
 Most manufacturing businesses are corporation because of the
large amount of resources required to operate
 Users of Accounting Information

11
 Cont…d
12

 The people who use accounting information basically fall in to

two categories:
1. External Users: External Users of accounting information are
parties, which are not directly involved in running the business
enterprise.
a. Lenders / Creditors- to assess the ability of borrowers to repay
their debts.
b. Share-holders (Stockholders)- judge the prospects for a
profitable investment.
c. Government- to collect tax
 The area of accounting aimed at serving external users is called
–Financial Accounting.
 Cont…d
13

2. Internal Users: These are persons that are directly

involved in managing and operating an organization.
a. Managers- to improve the efficiency and effectiveness
of an organization
b. Employees and labor Unions-to ask for bonuses,
when the organization is successful.
 The area of accounting aimed at serving the decision-

making needs of internal users is called Management

Accounting.
 The Accounting profession
14

 The accounting profession typically has two major

fields: Private Accounting and Public Accounting.
Private Accounting
 An accountant may be an employee of a business
enterprise or for not profit organization i.e. as a chief
accountant, controller, or financial vice president is said
to be engaged in Private Accounting.
 They are frequently referred to as managerial
accountants or cost accountants if they are employed by
a manufacturing concern
 Cont…d
15

Public Accounting
 In a public accounting, accountants offer expert services
to the general public on a fee basis.
 Public accountant who have met standard education,
experience and examination requirements may
become certified public accountants, commonly called
CPAs.
 Accounting Principles and
16
Practice
i) Business Entity Concept: implies that the business unit
is separate and distinct from the persons who provide
the required capital to it.
ii) Money Measurement Concept: In accounting all
events and transactions are recoded in terms of money.
iii) Going Concern Concept: the transactions are
recorded assuming that the business will exist for a
longer period of time, i.e., a business unit is considered
to be a going concern and not a liquidated one.
 Cont…d
17

iv) Dual Aspect Concept: According to this basic concept

of accounting, every transaction has a two-fold.
1. Giving certain benefits and
2. Receiving certain benefits.
 The basic principle of double entry system is that
every debit has a corresponding and equal amount of
credit.
 Cont…d
18

ix) Accrual Concept: According to this concept the

revenue is recognized on its sales and not on its actual
receipt.
 Similarly the costs are recognized when they are

incurred and not when payment is made.

x) Objective Evidence Concept: This concept ensures
that all accounting must be based on objective evidence,
i.e., every transaction recorded in the books of account
must have a verifiable document in support of its,
existence.
 Cont…d
19

xi) Consistency: refers to the state of accounting rules,

concepts, principles, practices and conventions being
observed and applied constantly, i.e., from one year to
another there should not be any change.
 Once you adapt an accounting principles or methods,

continue to follow it consistently in future accounting

periods.
xii) Disclosure : providing accurate, full and reliable
information and data in the financial statements which is
of material interest to the users and readers of such
statements.
 Cont…d
20

xiv) Materiality: - states that an accounting standard can

be ignored if the net impact of doing so has such a small
impact on the financial statements that a reader of the
financial statements would not be misled.
 Overview of International Financial Reporting
Standards (IFRS)
21

The term International Financial Reporting Standards

(IFRS) is basically known as a single set of accounting
standards, developed and maintained by the International
Accounting Standards Board with the intention of those
standards being capable of being applied on a globally
consistent basis—by developed, emerging and developing
economies—thus providing investors and other users of
financial statements with the ability to compare the
financial performance of publicly listed companies on a
like-for-like basis with their international peers.
IFRS - What is it?

 IFRSs are a single set of accounting standards

which specify how certain transactions and other
events should be reported in financial statements.
 The main purpose of these standards is to
maintain stability and transparency throughout
the financial world.
Financial Reporting: Why is it Important?

 No transparency => no trust

 No trust => no credit
 No credit => no investment
 No investment => no growth
 Overview of financial reporting requirements in Ethiopia and AABE

25

 implementing high quality International Financial

Reporting Standards (IFRS) is critical to meeting and
sustaining Ethiopia’s economic growth potential.
 IFRS provides international investors with a brand of
trust in the quality of financial reporting.
 That trust in financial reporting is essential if
investors are to be encouraged to step into promote
continued economic growth
26

 Recognizing the importance of high quality financial

reporting and its contribution to improved business
environment necessary to attract investment, the
Government of Ethiopia in 2014 passed the Financial
Reporting Proclamation 847/2014, —a groundbreaking
piece of legislation enshrining the accounting profession’s
role in fostering the growth of the economy and
 Cont…
27

 ensuring the stability of the economy; and the related

Council of Minsters Regulation setting-up the
oversight Board – the Accountants and Auditors Board
of Ethiopia (AABE).
 Objectives of the Board

28

AABE has clear and realistic statutory objectives which are:

 Promote high quality reporting of financial and related

information by reporting entities;

 Promote the highest professional standards among

auditors and accountants;

 Promote the quality of accounting and auditing services;

 Ensure the accountancy profession is used in the public

interest;
 Protect the professional independence of accountants and

auditors
 The Accounting Equation and Its elements
29

 Asset: An asset is a resource controlled by the entity as a result of

past events and from which future economic benefits are expected
to flow to the entity.
 Liability: A liability is a present obligation of the entity arising
from the past events, the settlement of which is expected to result
in an outflow from the entity of resources embodying economic
benefits, i.e. assets
 Owner’s Equity: Owner’s equity represents the claims by the
owner of a business to the assets of the business.
 The equation which shows the relationship between the above
elements is called accounting equation.
Assets =Liabilities +Owner’s Equity
 Business transactions and financial statements
30

 Business transactions are the occurrence of economic events of a

condition that should be recorded because they affect the financial
position of the business enterprise.
 are the raw materials of accounting reports
 Business transactions cause changes in the assets, liabilities, or
owner’s equity of a business enterprise /organization transactions
may be classified in to two broad groups
 External transaction : transactions occurred between the
organization and outsiders such as payment of debts, sales on
account, etc.,
 Internal transactions: Expiration or transfer of costs within the
firm. Such as depreciation of plant assets, estimation of doubtful
accounts expense.
 Transactions and the Accounting Equation
31

 All business transactions from the simplest to the

complex can be stated in terms of the resulting change
in the three basic elements of the accounting equation.

 However, it is important to remember that each

transaction leaves the equation in balance.

 Assets always equal the sum of liabilities and owner’s

equity.
 Illustration
32

 Suppose Ato Ashu Gemechu established a sole proprietorship to

be known as Ashu Garage, on September1, 2007. During
September, the business engages in the following transactions:
Transaction (1)- Ato Ashu starts business by depositing Br. 10,000
in a bank account opened in the name of Ashu Garage.
Transaction (2) - Garage bought land for Birr 7,500 in cash, to be
used as a future site for the business.
Transaction (3) -Ato Ashu purchases birr 850 of gasoline, oil and
other supplies from various suppliers agreeing to pay in the near
future.
Transaction (4) – During the month Ashu Garage paid Birr 400 to
creditors on account.
 Cont…d
33

Transaction 5 – During the first month of operation, Ashu Garage

earned service fees of Birr 4,500 receiving the amount in cash
for the garage services it rendered.
Transaction 6-During the month of September, Ashu Garage
incurred and paid wages, Birr 1,125; rent, Birr 850; utilities, Birr
150; miscellaneous, Birr 75.
Transaction 7- At the end of month it is determined that the cost
of the supplies on hand is Birr 250, the remainder (850-250)
having been used in the operations of the business.
Transaction 8- Ato Ashu Gemechu, the owner, withdrew Birr
1000 for his personal from the business.
 Assets Liability Owners equity
Tra. No Cash + Supplies + Land A/Payable AshuGem.Capital
1 +10,000 - - - + 10,000 O. Investment
Bal Birr 10,000 - - - Birr 10,000
2 34 -7,500 - + 7,500 - -
Bal Birr 2,500 - Birr 7,500 - Birr 10,000
3 - +850 +850
Bal Birr 2,500 Birr 850 Birr 7,500 Birr 850 Birr 10,000
4 -400 - -400
Bal Birr 2,100 Birr 850 Birr 7,500 Birr 450 Birr 10,000
5 + 4,500 - - - + 4,500 Service fee
Bal Birr 6,600 Birr 850 Birr 7,500 Birr 450 Birr 14,500
6 -2,200 - - - -1,125 Wages Exp.
-850 Rent Exp
-150 Utilities exp
-75 Misc exp

Bal Birr 4,400 Birr 850 Birr 7,500 Birr 450 Birr 12,300
7 - -600 - - -600 Supp exp
Bal Birr 4,400 Birr 250 Birr 7,500 Birr 450 Birr 11,700
8 -1,000 - - - -1,000 Withdrawal
Bal Birr 3,400 Birr 250 Birr 7,500 Birr 450 Birr 10,700
Total Assets =Birr 11,150 Total L and O. E = Birr 11,150
 FINANCIAL STATEMENTS OF BUSINESS
35

 After the effect of the individual transactions has been

determined, the essential information is communicated
to users at certain intervals.
 The accounting reports, which communicate this
information, are called financial statements.
 Financial statements are said to be the central features
of accounting because they are the primary means of
communicating important accounting information to
users.
 Financial statements are the means of transferring the
concise picture of the profitability and financial
position of the business to interested parties.
 1. Profit/loss Statement
36

 The Profit/loss statement is a financial statement that

summarizes the amount of revenues earned and
expenses incurred by a business over a period of time.
 It reports the profitability of the business by comparing
revenues and expenses for a stated period of time such
as a month or a year.
 If the revenue of a period exceeds the expenses of that
same period, net income results.
 If expenses are greater than the revenues of a period, we
say there is a net loss, that is, the business has operated
unprofitably.
 Cont…d
37
Ashu Garage
Profit/Loss Statement
For the Month Ended September 30, 2007

Revenues:
Service Fee Birr 4,500.00
Expenses:
Wages Expense Birr 1,125.00
Rent Expense 850.00
Supplies Expense 600.00
Utilities Expense 150.00
Misc. Expense 75.00
Total Expenses Birr 2,800.00
Net Income Birr 1,700.00
 2. Owner’s Equity Statement
38

 This is a statement that summarizes the changes in

owner’s equity for a specific period of time.
 Owners equity is affected the following factories

Owner’s Equity

Decreased by: Increased by: Owner’s Investment and

Owner’s withdrawals and Expenses Revenues
 Cont…d
39

Ashu Garage
Statement of Owner’s Equity
For the Month ended September 30, 2007

Ashu G. Capital, September1 Birr -0-

Add: Investments during the month Birr 10,000.00
Net income 1,700.00
11,700.00
Less: Drawings 1,000.00
Ashu G. Capital, September 30 Birr 10,700.00
 3. Statement of Financial Position
40

 It’s lists the company’s assets, liabilities and owner’s equity

as of a specific date- usually at the end of a month or year.
 There are two commonly used formats of the balance sheet:
 The account format: This lists assets on the left side and
equities (i.e. liability and owner’s equity) on the right side.
Assets =Liability + Owner’s Equity
 The Report Format -Lists assets, Liability and Owner’s
equity vertically
Assets
Liability 
Owner’s Equity
 Cont…d
41

Ashu Garage
Statement of Financial Position
September 30, 2007

Assets Liability
Land………………7,500.00 Accounts payable…… Birr 450.00
Supplies……………250.00 Owner’s Equity
Cash…………Birr 3,400.00 Ato Ashu Gem., Capital Br10, 700.00.
_________ Total Liabilities and
Total Assets……..11,150.00 Owner’s equity……...Birr 11,150.00
 4. Statement of cash flows
42

 The statement of cash flows consists of three sections

1 Cash Flows from Operating Activities:-reports a summary of
cash receipts and cash payments from operations.
 The net cash flow from operating activities will normally differ

from the amount of net income for the period because revenues
and expenses may not be recorded at the same time that cash is
received from customers or paid to creditors.
2 Cash Flows from Investing Activities:-reports the cash
transactions for the acquisition and sale of relatively permanent
assets.
3 Cash Flows from Financing Activities:-reports the cash
transactions related to cash investments by the owner,
borrowings, and cash withdrawals by the owner.
 Ashu Garage
Statement of cash flows
September 30, 2007
43

 Cash flows from operating activities

Cash received from customers Birr 4,500.00
Cash payments for expenses and creditors: ( Birr 2,600.00)
Net Cash flows from operating activities Birr 1,900.00
 Cash flows from investing activities
Cash payments for acquisition of land (Birr 7,500.00)
 Cash flows from financing activities
Cash received as owner’s investment Birr 10,000.00
Cash withdrawals by owner (Birr 1,000.00)
Net cash flows from financing activities Birr 9,000.00
Net cash flow and cash bal. September 30 Birr 3,400.00
 Financial Statement for Corporation
44

Retained Earnings Statement

 A statement of retained earnings or a statement of stockholders’ equity

is included with every set of financial statements of a corporate type of

business enterprises.
 In a corporate enterprise the emphasis in reporting changes in

stockholders (owners’) equity is on the changes in retained earnings,

or net income retained in the business.
 The changes in retained earnings that have occurred during a period

are reported in a retained earnings statement.

 In a corporate (corporation) business, changes in the amount of

earnings retained in the business would have resulted from:

1. Net income, and
2. Distribution of earnings, called dividends, to owners.
 Cont…d
45

Ashu Garage
Retained Earnings Statement
For Month Ended Sept 30, 2007

Net Income for the Month.............................................. ………Birr 1,700

Less: Dividends..................................................................................1,000
Retained Earnings, September 30, 2007..................... …………..Birr 700
 
 Cont…d
46 Ashu Garage
Financial position statement
September 30, 2007

Assets
Land ........................................................................................ Birr 7,500
Supplies .................................................................................. 250
Cash.........................................................................................  3,400
Total assets.............................................................................. Birr 11,150
Liabilities
Account payable...................................................................... Birr 450
Stockholders’ Equity
Capital stock........................................................................... Birr 10,000
Retained Earnings................................................................... 700
Total Stockholders’ Equity ................................................... 10,700
Total Liabilities and Stock holders’ Equity............................ Birr 11,150
 Cont…d
47

Ashu Garage
A Statement Of Cash Flows
For Month Ended September 30, 2007
Cash flows from operating activities:
Cash received from customers........................................ Birr 4,500
Deduct cash payments for expenses and
Payments to creditors ................................................... 2,600
Net cash flow from operating activities.................................... Birr 1,900
Cash flows from investing activities:
Cash payments for acquisition of land................................... (7,500)
Cash flows from financing activities:
Cash received from sale of capital stock...................... Birr 10,000
Deduct: cash payments for dividends.......................... (1,000)
Net cash flow from financing activities....................... 9,000
Net cash flows and September 30, 2007 cash balance.............. Birr 3,400
48

End
Of
Ch-1