BBA 2101: Financial Accounting

Unit one: Introduction

Meaning of Accounting
Accounting is known as the language of business where business information is communicated
to decision makers. The question then is, how do you communicate? And what do you have to
communicate as a business? Who are you communicating to? Why are you communicating to
them? What constitutes good communication?

In a technical sense, Accounting is a process of recording, classifying, summarizing, and

communicating business information (financial information) to decision makers.
What is accountability? Accountability can be defined as an obligation of an individual, firm, or
institution to account for its activities, accept responsibility for them, and to disclose the results
in a transparent manner. It also includes the responsibility for money or other entrusted property.
How does one become accountable?
- Provide documentary evidence e.g. such documents as. LPOs, Delivery note etc.
- Prepare books of accounts; cash book, ledgers etc.
- Financial reports/statements.
- Physical items; this helps to assess value for money.

Who interested in accounting information?

Internal users: Management, Employees
External Users: Investors, Creditors, Government etc.
What particular information are they interested in? Where can they find it?
User Main information needs
Management  Assess profitability of the whole business, branch, product etc
 Control the business e.g. by comparing the budget with actual results
 Plan for the future e.g. budgets, cash requirements etc.
 Information must be detailed and up to date e.g. monthly
Investors  Profitability of the firm by examining past and future performance
  Security of their investments e.g. the financial strength shown by the
balance sheet
Lenders  The cash position and solvency of the business to establish whether the
loans and interest will be
 The value of assets for security for loans in the balance sheet
Suppliers Ability to pay debts by examining the financial position

Customers Want to know whether the business will continue to supply them in the
future going concern issues, sales growth, new product development
investment in the business e.g. production capacity
Competitors Performance of others in order to make strategic plans

Employees  Secure employment

 Possible pay rises by looking at the profitability of the business
 Salaries and benefits enjoyed by senior management
 Profitability of branches to check possible redundancies in case of
closure
 Maintenance of pension funding & retirement benefits
Government  Performance of the in order to formulate economic policies
 Tax authorities use financial statements for tax assessment
 Regulation of competition, takeovers, grants
 Environment issues
The public  Provision of local employment by examining profitability and
expansion plans
 Corporate social responsibility programmes
 Product / service quality
 Environmental issues
 Branches of Accounting
 Financial Accounting: this branch of accounting is concerned with the preparation of financial
statements and its focus primary focus is to provide information to external Users. The internal
users also find this information useful. Statements produced include; Statement of
Comprehensive income, Statement of Financial Position, Cashflow Statement, Statement of
changes in equity(Capital+ Reserves+ Share premium+ Net profit/Retained profits-Net loss-
Drawings). What do each of these statements communicate?
This branch of evolved to be significant due to globalization, stewardship, accountability, agency
theory (Agency theory is a theory concerning the relationship between a principal (shareholder)
and an agent of the principal (company's managers), information asymmetry and various
accounting scandals (Enron and the Worldcom Corporation Accounting scandal) etc. Accounting
scandals did;
- Over valuation of inventory
- Improper capitalization of Business expenses
- Overstating of Business expenses
- Understating Business expenses
- Overstating financial returns
- Understating financial returns
- Delayed reporting of expenses and other elements.
- Pension funds frauds

 Cost Accounting: this is concerned with the determination/ascertainment and allocation of costs
to products and services. A cost is a representation of resources that it takes to produce a product
or service. Costing techniques are used such as standard costing & variance analysis, target
costing, job costing, batch costing etc. the focus of this branch is cost ascertainment and cost
control.
 Management Accounting: The emphasis of management accounting is to provide information
to the managers of the entity only. This information helps them perform their managerial duties
such as planning, organizing, controlling etc. The information provided relates to Budgets,
forecasts, performance reports and projections.
 Auditing: This is done by professional accountants (CPA, ACCA) such that where the work of
the Accountants is examined in order to express an opinion on the status of the entity’s financial
statements. This s to ascertain as to whether it truthfully represents the state of affairs of business
transactions and also the guiding reporting framework.
 Social Responsibility Accounting/Environment Accounting: The focus is put on health and
safety measures, and environmental protection strategies. This is where some firms may made
huge profits but at the expense of the environment.
 Public sector Accounting: this is where government entities/agencies report on their financial
transactions; entities such at government schools, hospitals etc. Public sector accounting is about
accountability and value for money. It involves both financial and management accounting

The Accounting Regulatory framework (accounting Rules)

Due to the fact that there are several users of accounting information, there needs to be rules that
guide the preparation of this information so that it meets the needs of the users. It ensures that
information provided by accountants if free from bias, is of good quality and credible.
The regulatory framework for the preparation of financial statements in Uganda includes the
following:
 International financial reporting standards (IFRSs)
 The Companies Act and other relevant laws
 The capital market regulations for listed companies.

The need for regulation

 The financial statements are used by a wide range of users.
 To ensure financial statements are useful to users.
 To make financial statements comparable.
 To ensure the financial statements have the basic information on the entity’s financial
position and performance.
 To increase the users understanding of and confidence in financial statements.
 To regulate the behavior of companies towards their investors.
 Qualities of good accounting information
Relevance: Accounting information that is availed should be relevant to a specific economic
decision; financing, investing and operating decisions. It should serve the purpose for which is
has been prepared.
Reliability: Good accounting information is one that can be relied on to make a certain decision
and it ought to be free from material errors. (Materiality concept).
Understandability: Accounting information should be clear to the users in order for the users to
be able to extract meaning from it. As earlier said, accounting is the language of business.
Comparability: Accounting information should be easy to compare either with Budget
forecasts, preceding years or similar entities. This calls for respect of the consistency concept.
(E.g. using the same inventory valuation (FIFO, LIFO, WAC) and depreciation methods (straight
line, reducing balance) for quite long period of time until management decides otherwise).

 Accounting assumptions/ concepts/principles/conventions

Accounting concepts are guidelines in the recording of financial transactions and preparation of
financial statements. Accounting concepts include the following:
 Business entity concept: when the business is set up, it is fully incorporated under the law and it
becomes a separate legal entity with the ability to sue or be sued. Even a sole proprietorship,
books of accounts are prepared as if the business is separate from its owner; here we usually
recognize drawings and capital as well as other elements.
 Money measurement concept: As earlier put, accounting focuses on recording financial
transaction relating to the business. Non-monetary transactions are eliminated. Money is
preferred because it’s an easy measure of value and comparison. How do you recognize
employees as an asset in a business sense?
 Going concern concept: this concept states that the business entity is assumed to continue in
operational existence in the foreseeable future. E.g. Cashflow projections, depreciation of non-
current assets, obtaining non-current liabilities etc.
 Consistency concept: Accounting practices should remain the same year after year. For
example, the use of uniform depreciation method; say, straight-line or Reducing balance method,
 and inventory valuation method; say FIFO or LIFO, becomes crucial, as this would ease
comparison of different years’ financial performance.
 Prudence concept: preparation of accounts involves estimations, measurements and valuations.
This concept requires that a measurement that tends to understate values should be preferred.
Overstating of profits is avoided. This calls for aspects like provision for bad and doubtful debts.
The firm is expected to anticipate no profits, but provide for all possible losses.
 Historical Cost/Cost concept: Assets and liabilities are recognized at the historical cost of their
acquisition. E.g. Vehicles, PPE, Land, Loans etc.
 Periodicity and disclosure concept: This exists in the Companies Act of Uganda where all
companies are required to prepare and publish their financial statements for the financial
year/accounting period.
 Duality concept: Accounting transactions should be handled under a two-fold aspect;
 A/c to be debited and
 A/c to be credited
 Matching concept: Revenues are matched with expenses. Adjustments for accruals and
prepayments should be made. E.g. if rent worth Ugx 1,600,000 of a rental unit worth Ugx
100,000 per month, then when preparing a financial statement at the end of the year, only Ugx
1,200,000 will be taken as the rent expense figure and the remaining Ugx 400,000 as a prepaid
expense or as an asset.
 Accrual concept: A transaction is recognized at the point of occurrence and not only when cash
is received or paid out. E.g. Income is recorded as earned even though it might not have been
received as cash. Expenses are recognized as incurred even when they have not been paid for.
 Materiality: Information is material if its omission or misstatements could be expected to
influence the economic decisions of the users. All information that is material should be given in
the financial statements and information that is not material need not be given. Materiality
depends on the size and nature of the item and the size of the business.

The Accounting Equation

This equation defines the relationship between assets, liabilities and owner’s equity or capital.
Assets = liabilities + Capital
 Accounting elements (ALICE)
 Assets: These are resources that controlled by the entity, have a monetary value and from which
future economic benefits are expected to flow towards the entity. Those that bring in money to
the business. The Assets are either, Non-current assets: Resources that remain in the Business for
a period of more than one accounting period. Examples are; Buildings, land, machinery,
equipment, etc. OR Current assets: Resources that remain in Business within one accounting
period. Examples include; inventory, trade receivables, prepaid expenses, accrued incomes, etc.
The assets may also be intangible assets such as good will, trademark, and patents.

 Liabilities: Obligations to be settled by the Business. The settlement of these liabilities results in
the outflow of cash from the entity. They can be Non-current liabilities: Obligations that remain
with the Business for more than one accounting period. Examples include; Long-term loans,
Debentures, Bonds, etc. OR Current liabilities: Obligations that are settled within one accounting
period. Examples include; Trade payables, Bank overdrafts, short-term loans, accrued expenses,
prepared income, etc.

 Incomes: These are economic benefits coming into the Business (Inflows) during an accounting
period. They may be as a results of business operations or inherent from one-off events such as
disposal of assets. Incomes include; Revenues and gains.

 Capital/Equity: Resources brought into the Business by the owners. It is money owed by the
business to its owners. These resources include; capital, reserves, share premium and net
income/retained earnings.
Note: Owner’s equity is increased by additional capital and profit but is reduced by drawings.
 Revenues: Economic benefits generated from the ordinary course of the Business, e.g sales
revenue.
 Gains: Economic benefits that may or may not originate from the ordinary course of the
Business. Examples of gains include; gains on disposal of Non-current assets, rental income, and
sale of investments or subsidiaries.
 Expenses: These are decreases in economic benefits (outflows) during an accounting period.
Expenses decrease assets and may increase liabilities of the Business. In addition, expenses are
incurred in the ordinary course of the Business. Examples of expenses include; Accrued salaries
at the end of accounting period, salaries expenses, insurance, etc.

Effect of transactions on elements of financial statements

Elements/Account Increase Decrease Normal balance
Asset Dr Cr Dr
Liability Cr Dr Cr
Income Cr Dr Cr
Capital Cr Dr Cr
Expenses Dr Cr Dr
Drawings Dr Cr Dr
Dividends Dr Cr Dr

Chart of accounts
Chart of accounts refers to categories or classes of accounts. The main categories of accounts
are; Personal, nominal and real (asset) accounts; with a number of subcategories as indicated
below.

Personal accounts Real (asset) accounts

Natural Artificial Representatives Tangible Intangible

Nominal accounts

Expenses/ losses Incomes:

Revenues /gains
 Personal accounts: under this category, we have;
Natural personal accounts: these constitute of accounts for persons created by God. Examples of
natural personal accounts include; Aggrey A/C, Musiime A/c, Kirabo A/c, etc.
Artificial personal accounts: Accounts of entities created by human beings. Examples of such
accounts include; Accounts of corporations, clubs, associations, government bodies, etc.
Representative accounts: Accounts representing certain persons or group of persons. Examples
are; rent due to landlords, salaries prepaid, income received in advance, etc.

 Real accounts: Accounts for assets-Non-current and current accounts.

Tangible real accounts: These accounts for assets that can be touched, felt and measured.
Examples are; Buildings, machinery, furniture and fittings, etc.
Intangible real assets: Accounts for assets that cannot be touched, felt but can be measured, and
have monetary value. Examples of such accounts include accounts for Goodwill, copy rights,
patent rights, etc.
 Nominal accounts: Accounts that present movement of cash-Inflows and outflows of cash.
Incomes (Revenues/gains accounts): Accounts for inflows resulting from ordinary course of
Business (Incomes; e.g sales revenue). Still, accounts for inflows from or not from ordinary
course of Business (Gains; e.g gains from disposal of Non-current assets).
Expenses accounts: Accounts for outflows of cash resulting from ordinary course of Business.
Examples are accounts for insurance, rent and rates, consultancy fees, etc.

From the following transactions, find out the nature of accounts involved:
- Land sold for shs 30,000,000 cash.
- Machinery bought by Cheque for shs 16,600,000.
- Cash shs 8,700,000 withdrawn from the safe and banked on the company’s account with
Stanbic Bank.
- Water expense paid by cheaque shs 4,500,000.
- Goodwill shs 5,000,000 was received from a new partner and immediately withdrawn
from the business by the old partner.
The Accounting Equation
Assets = liabilities + Capital
The accounting equation helps us illustrate business transactions and their effect on the affairs of
the business in terms of financial performance and also the health of the business in terms of
liquidity.
Illustration
Construct equations for each of the following transactions and prepare a simple balance sheet at
the conclusion of all the transactions.
i) Milton started a business with 5,000,000 cash at hand and 10,000,000 cash at bank.
ii) He purchased inventory of goods for 3,000,000 paying 50% cash and 50% on credit. He
went ahead and sold 2/3 of the inventory at 2,500,000 credit.
iii) Paid rent 100,000 by cash.
iv) Received cash payment of 2,000,000 from debtors and paid 1,000,000 cash to suppliers.
v) Bought a motor vehicle for 6,000,000, of which he paid 2,000,000 by cheque, 1,000,000
by cash and promised to pay the balance later.
vi) Sold half the remaining inventory for 700,000 of which he collected immediate cash of
200,000 and the balance was to be received later.
vii) Paid electricity worth 200,000 by cheque.
viii) Used business cash worth 200,000 to buy his wife a gomesi.
ix) Acquired a loan of 4,000,000 by cash. The loan was to be repaid in 2 years’ time.

Coursework 1
Construct an accounting equation to reflect the following equations and prepare a statement of
financial position and a statement of profit or loss and other comprehensive incomes.
i) Fred commences business with cash of 40,000,000 from his own savings and further cash
10,000,000 from his cousin. His cousin informs him that he isn’t looking for interest or
early repayment.
ii) Fred buys the following assets for the business;
- Motor Vehicle 5,000,000 by cash
 - Inventory worth 8,000,000 (half by cash, half by credit)
iii) He sells half the inventory at 4,000,000, 50% cash and 50% on credit and pays his
creditors for inventory in full.
iv) Fred buys second hand delivery Van for 3,000,000 on credit to facilitate the business.
v) He sells the remaining inventory for 4,500,000 by cheque and on the same day he
receives payment of 1,000,000 in cash from his debtors.
vi) The motor vehicle breaks down and requires 100,000 for repairs which Fred pays in cash.
vii) At Christmas, Fred buys his wife a food mixer costing 100,000 and his secretary a Dior
jacket worth 50,000. He pays for both items using his credit card.
viii) Fred pays 400,000 cash for advertising and 200,000 cash for audit fees.
ix) His auditors advise him that he should write off the debt of 100,000 because in their
opinion, it’s now irrecoverable. They also recommend that he provides for depreciation
on Motor vehicle at a rate of 25% on cost per annum. These assets have been used for
one month.
x) Fred withdraws 2,000,000 in cash for personal needs.