Chapter # 1 Introduction to Accounting

Financial Reporting
A way of recording, analyzing and summarizing financial data.

Financial Data
Actual transactions carried out by the business e.g. sales of goods, purchase of assets,
acquisition of bank loan, payment of expenses etc.

Business
An integrated set of activities and assets that are utilized in a manner to generate economic
benefits for the investor, owner or member

Types of
Business

Limited
Sole trader liability Partnerships
companies

Owned by multiple Arrangement b/w

Owned and run by a individuals but multiple individuals to
single individual managed by carry out business
managers with common interest

Characteristics of Different Types of Business

Sole Trader Limited Liability Companies Partnership
Owned By
One person Several individuals working Shareholders
together
Liabilities for the unpaid debts and other obligations of the business
Personal liability of the Personal liability of partners Limited
owner
 Management
Business managed by its sole Business managed by its Larger companies are
owner owners managed by professional
managers
Raising Capital
Capital for the business is Capital for the business is Capital for the business is
provided by its sole owner provided by its owners provided by its shareholders
Need For Financial Accounting
Some financial accounts Financial accounts needed Fairly strict regulation of
needed for tax purpose for the benefits of partners financial reporting by
and for tax purpose companies.

Financial Accounting
Financial accounting is a term that describes:
 Maintaining a system of accounting records for business transactions and other items of
a financial nature; and
 Reporting the financial position and the financial performance of an entity in a set of
financial statements.
The term entity is used to describe any type of organization. Business entities include
companies, business partnerships and the businesses of ‘sole traders’
Although financial accounts are of interest to management, their principal function is to satisfy
the information needs of persons not involved in running the business. They provide historical
information. Financial accounting is mainly a method of reporting the financial performance
and financial position of a business.

Management Accounting
Management accounting is concerned with providing information to management that can be
used to help run the business.
 The purpose of management accounting is to provide detailed financial information to
management, so that they can plan and control the activities or operations for which
they are responsible.
 Management accounting information is also provided to help managers make other
decisions. In other words, management accounting provides management information
to assist with planning, control and ‘one-off’ decisions.
The Need for Financial Statements
There are various groups of people who need information about the activities of a business.
'The objective of financial statements is to provide information about the financial position,
performance and changes in financial position of an entity that is useful to a wide range of
users in making economic decisions.'
The following people are likely to be interested in financial information about a large company
with shares that are listed on a stock exchange.

Users of Financial Statements

and Accounting Information

Managers of the company Shareolders Employees

They are responsible for The want to assess how well Employees need information
producing the FS and might be the company is performing about the financial stability
interested in the information and its profitability to make and profitability of their
they contain investment decisions employer to asses their career
prospects

Lenders Taxation Authorities Financial Analysts

Banks and longterm credit They want to know about They need info for their
issuers want to ensure that business profits in order to clients or audience
the company will pay its assess the tax payable by the
interest and loan amount on company
time

Government Public Suppliers and Costumers

Govt. might use this In some cases, general public Suppliers want to know about
information for the purpose might have an interest in the the company's ability to pay
of business regulation or FS of a company as entities its debts; customers need to
deciding taxation policies and make a substantial know that the company is a
also for resource allocation contribution to the local secure source of supply and
economy will not close down.
 Components Of Financial
Statements

Statement of Statement of Statement of Notes to

Statement
Financial Changes in Comprehensive Financial
Of Cahsflows
Position Equity Income Statements

Statement of Financial Position (SOFP)

It is simply a list of all assets owned and liabilities owed by a business at a particular date. It
consists of following elements.
 Assets
An asset is a resource controlled by an entity as a result of past events and from which
future economic benefits are expected to flow to the entity. Examples of assets are
factories, office buildings, warehouses, delivery vans, lorries, plant and machinery etc.
 Liabilities
A liability is a present obligation of the entity arising from past events, the settlement of
which is expected to result in an outflow from the entity of resources embodying
economic benefits. Examples of liabilities are amounts owed to a supplier for goods
bought on credit, amounts owed to a bank (or other lender), a bank overdraft and
amounts owed to tax authorities
 Capital or equity
Equity is the residual interest in the assets of the entity after deducting all its liabilities

The SOFP is based on the principle of accounting equation i.e.

Asset = Liabilities + Capital or Equity
and it suggests assets will always be equal to liabilities plus capital (or equity).
Basic Form of Statement of Financial Position
(Illustrative example)
A Trader
Statement of Financial Position
As At December 31, 20X2
Assets Rupees Rupees
Land 25,000
Building 23,000
Vehicle 13,500
Stock in Hand 13,000
Trade Receivables 5,600
Prepayments 2,500
Cash and Bank 1,400
9,500
Total Assets 84,000

Capital
Balance Brought Forward 19000
Profit for the Year 34000
Additional investment 12500
Less: Drawings (6500)
Balance Carried Forward 59,000
Liabilities
Bank Loan 13400
Trade Payables 8700
Accruals 1600
Other Payables 1300
Total Liabilities 25,000
Total Liabilities and Capital 84,000

Statement of Comprehensive Income (SOCI)

A statement of profit or loss is a record of income generated and expenditure incurred over a
given period. It usually consists of following elements:
 Revenue
It is the income generated by the entity through either sale of a product, provision of a
services or by any other means.
 Expenses
These are the costs of running the business for the same period. Examples are rent
expense, utility bills, fuel expense, depreciation expenses etc.
Basic Form of Statement of Comprehensive Income
(Illustrative example)
A Trader
Statement of Comprehensive Income
As At December 31, 20X2
Revenue
Sales 76,000
Sales Return (1,500)
Net Sales 74,500

Cost Of Goods Sold

Opening Stock 12,000
Purchases 27,000
Closing Stock (13,500)
Transportation in 1,500
Cost of Goods Sold (27,000)
Gross Profit 47,500

Expenses
Depreciation Expense 3,200
Rent Expense 2,500
Electricity Expense 950
Fuel Expense 4,500
Salaries and wages 1,850
Bad Debt Expense 500
Total Expense (13,500)
Net Profit 34,000

Governance and Responsibility for Financial Statements

Those charged with governance of a company are responsible for the preparation of the
financial statements. The board of directors of a company are usually the top management
and are those who are charged with governance of that company and are primarily
responsible for the preparation of financial statements.

Company, Ownership And Control

A company is a corporate body that has registered in accordance with the requirements of relevant
national company law (e.g. the Companies Act 2017), thus becoming its own legal entity. Ownership of
the company is evidenced by the issuing of shares to the owners (i.e. the shareholders).
For some smaller and medium sized companies the owners may also be the directors/managers of the
company. However, in typically large, listed companies directors are appointed to manage the business
on behalf of the owners. This leads to the separation of ownership and control within the company.

Corporate Governance
The system by which companies are directed and controlled in the interests of shareholders and in
relation to those stakeholders beyond the company boundaries.
Directors of a company have a responsibility to these groups then they must also be held accountable
to them.
Purpose and objectives of corporate governance
Corporate Governance
Purpose Objectives
Primary Primary
Monitor those parties within a company who Contribute to improved corporate performance
control the resources owned by the investors and accountability in creating long-term
shareholder value
Secondary Secondary
 Ensure there is suitable balance of power  Control the controllers by increasing the
in the board of directors amount of reporting and disclosure to all
 Ensure executive directors are stakeholders
remunerated fairly  Increase the level of confidence and
 Make the board of directors responsible transparency in company activities for all
for monitoring and managing risk investors
 Ensure the external auditors remain  Ensure that the company is run in a legal
independent and free from the influence and ethical manner
of the company  Build in control at the top that will
‘cascade’ down the organisation
The responsibilities and duties of directors are usually laid down in law and are wide ranging.
Corporate governance is the system by which companies and other entities are directed and
controlled. Good corporate governance is important because the owners of a company and
the people who manage the company are not always the same, which can lead to conflicts of
interest.

Directors are responsible for the preparation of the financial statements of the company.
Specifically, directors are responsible for:
 The preparation of the financial statements of the company in accordance with the
applicable financial reporting framework (e.g. IFRSs)
 The internal controls necessary to enable the preparation of financial statements that
are free from material misstatement, whether due to error or fraud
 The prevention and detection of fraud
It is the directors' responsibility to ensure that the entity complies with the relevant laws and
regulations. The legal duties of directors are as under:
 Act within their powers
 Promote the success of the company
 Exercise independent judgement
 Exercise reasonable skill, care and diligence
 Avoid conflicts of interest
 Not accept benefits from third parties
 Declare an interest in a proposed transaction or arrangement
When exercising this duty directors should consider:
 The consequences of decisions in the long term
 The interests of their employees
 The need to develop good relationships with customers and suppliers
 The impact of the company on the local community and the environment
 The desirability of maintaining high standards of business conduct and a good
reputation
 The need to act fairly as between all members of the company