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Cape Accounting Unit 1 (Notes 1)

Financial accounting involves recording, summarizing, and reporting business transactions over time, usually a year. It keeps track of a company's financial transactions for external users and is guided by GAAP. The transactions are recorded and presented in statements like income statements and balance sheets.

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0% found this document useful (0 votes)
868 views21 pages

Cape Accounting Unit 1 (Notes 1)

Financial accounting involves recording, summarizing, and reporting business transactions over time, usually a year. It keeps track of a company's financial transactions for external users and is guided by GAAP. The transactions are recorded and presented in statements like income statements and balance sheets.

Uploaded by

DWAYNE HARVEY
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as DOCX, PDF, TXT or read online on Scribd
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CAPE ACCOUNTING UNIT 1

FINANCIAL ACCOUNTING

TEACHER: Mr E. Tucker CLASS NOTES (1)

Topic: What is financial Accounting?

Financial accounting is a specific branch of accounting involving a process of recording,


summarizing, and reporting the myriad of transactions resulting from business operations over a
period of time – usually one year. Financial accounting keeps track of a company's financial
transactions. It is an information service that focuses on the preparation of accounting
information for external users mainly. It is guided by generally accepted accounting principles
(GAAPs). It is historical in nature and reports accounting information about the entire business
rather than on its parts. Its focus is also on the generation of financial numbers using
standardized guidelines. The transactions are recorded, summarized, and presented in financial
reports or financial statements such as income statements or balance sheets.

Financial Reporting: Financial reporting is a broader concept than financial statements. In


addition to the financial statements, financial reporting includes the company's annual report to
stockholders, its annual report to the Securities and Exchange Commission (Form 10-K), its
proxy statement, and other financial information reported by the company.

Financial Accounting vs. "Other" Accounting: Financial accounting represents just one


sector in the field of business accounting. Another sector, managerial accounting, is so named because it
provides financial information to a company's management. This information is generally internal (not
distributed outside of the company) and is primarily used by management to make decisions. Other
sectors of the accounting field include cost accounting, tax accounting, and auditing.
Which of the following is not a characteristic of financial accounting?

A. It is prepared to satisfy the needs of external users.

B. It measures and reports costing information for future use.

C. It is guided by generally accepted accounting principles.

D. It focuses on ‘numbers’ rather than key business issues.

The Development of Accounting


Accounting is the system of recording, classifying and summarizing financial information in
such a way that users of the information can make economic decisions based upon it. Accounting
began as a simple system of clay tokens to keep track of goods and animals, but has developed
throughout history into a way of keeping track of complex transactions and other financial
information.
Early Accounting

Accountancy has its roots in the earliest history of civilization. With the rise of agriculture and
trade, people needed a way to keep track of their goods and of transactions. Around 7500 B.C.,
Mesopotamians began using clay tokens to represent goods, such as animals, tools, food items or
units of grain. This helped owners keep track of their property. Instead of counting heads of
cattle or bushels of grain every time one was consumed or traded, people could simply add or
subtract tokens. Different shapes were used for different goods. Around 4000 B.C., the
Sumerians began placing these tokens in sealed clay envelopes. Each token would be stamped
into the clay of the outside of the envelope, so the owner would know how many tokens were
inside, but the tokens themselves would be kept safe from tampering or loss. This practice of
pressing the tokens into the clay may have been the earliest genesis of writing. A few hundred
years later, more complex tokens began to be used. These tokens had special markings to denote
different units or types of goods. Starting around 3000 B.C., the Chinese developed the abacus, a
tool for counting and calculating. https://bizfluent.com/

Double-entry Bookkeeping and Luca Pacioli

Throughout much of ancient history and the Middle Ages, accountancy remained a fairly simple
affair. The adoption of coinage meant that accounting now dealt with money rather than actual
goods, but single-entry bookkeeping, much like that used in modern check registers, was used to
keep track of money exchanged, where it went and who owed what. During and after the
Crusades, European trade markets opened up to Middle Eastern trade, and European merchants,
especially in Genoa and Venice, became increasingly wealthy. They needed a better way to keep
track of large amounts of money and complex transactions, and this led to the development of
double-entry bookkeeping. Double-entry bookkeeping means that each transaction is recorded at
least twice, one as a debit to one account and a credit to another. In 1494, a Franciscan monk
and mathematician named Luca Pacioli published a math book titled "Summa de arithmetica,
geometria, proportione et proportionalita," which contained a description of double-entry
accounting. As the book's popularity grew, double-entry accounting began to sweep Europe, as
merchants realized what a valuable tool it gave them for keeping track of detailed financial
information. For this accomplishment, Luca Pacioli is often called the "Father of Accounting."
Still, at this point in history, accountancy was not yet a specific profession, but rather an
extension of the clerical duties of scribes, officials, bankers and merchants.

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02:5209: Modern Professional Accounting


Today, accounting is a business unto itself, with thousands of practitioners worldwide and a large
number of professional organizations and official guidelines to codify practices and
requirements. Particularly in the United States during the Great Depression, demands were made
for better standardization of accounting practices and a set code of professional guidelines.
Additionally, unfortunate financial situations such as “The fall of ENRON”, paved the way for
more stringent disclosure requirements.

Today, the Generally Accepted Accounting Principles, or GAAP, set forth the standards by
which public accountants must do business. Also, the development of standards by the
International Accounting Standards (IAS) by the IASC and later the IFRS and the IFRS for
SMEs by the IASB helped to harmonize the way we record accounting information.

The following insert is the findings from the Bureau of Labour Statistics where over 1.4 million
jobs in accounting were created in 2019 and is expected to grow by another 4% across in the
USA. Locally, the Department of Career Services at The University of the West Indies, mona
has reported that most interviews done were for accounting jobs in 2017.

. Accounting Today reported that there are other challenges facing


accountants and accounting firms, including staffing, tax reform, cybersecurity, “merger mania”
and the demand for more Certified Public Accountants.
Activity: Based on the development of accounting process, identify:

1. Identify 2 situation that existed in the early years.

2. Identify 2 situations that existed in the middle years

3. Identify 2 factors that contributes to the development of accounting today


SIGNIFICANCE AND LIMITATIONS OF ACCOUNTING
INFORMATION.
Accounting plays a vital role in running a business because it helps you track income and
expenditures, ensure statutory compliance, and provide investors, management, and government
with quantitative financial information which can be used in making business decisions. These
significance may be listed as advantages of the use of accounting information. Some
significances highlighted are given below:

Other Significances include:

● To make decisions about the business.

● Assess profitability and financial stability.

● To determine credit worthiness.

● To assist in planning, controlling and decision making.

● To prevent fraud/ theft of assets.

Limitations of Accounting

Accounting information can be used to assist both financial and managerial oriented decisions. In
order to come to effective financial or managerial decisions, many factors other than accounting
should be duly considered. Accounting information is extremely vital in/and for all enterprises
though it does have certain limitations.

● Measurability: One of the biggest limitations of accounting is that it cannot measure


things/events that do not have a monetary value. ...
● No Future Assesment: Accounting information is prepared for a past period of time.
● Historical Costs: assets and liabilities are recorded at their historical values despite
inflation or other factors.
● Accounting Policies: Different companies my use different accounting policies, thus
limiting comparisons.
● Estimates: Figures on the financial statements or in the accounting information in
general are estimated or based on judgments.
● Verifiability.
● Errors and Frauds may be included in the accounting information..
● The information may be prone to window dressing.

OTHER Limitations
1. The Process is time consuming.

2. May not be accurate since it depends on estimates and judgements.

3. It may be costly to prepare and cost may outweigh its benefits. (cost/benefit
analysis).
4. It doesn’t provide details of why figures are as they are.

5. It doesn’t explain the social aspect of the business.

6. It doesn’t accommodate changes in season of effect of inflation.

7. It may accommodate ‘window dressing’.


The significance and limitations of accounting information may be discussed as the advantages
and disadvantages of the use of accounting information as is listed below:.
Accounting information of a business enterprise is used by many stakeholders. Different parties
use this information for different purposes depending on their needs. Therefore, the accounting
information system of a business enterprise must be designed in a way that it should generate the
reports to satisfy the information needs of every interested party.

We can broadly divide the users of accounting information into two groups – internal users and
external users. Internal users include managers, owners and employees of the business whereas
external users include investors, creditors of funds, suppliers of goods, government agencies,
general public, customers etc.

Users and uses of Accounting Information

Debtors/Customers
To check if the supplier is financially stable and if not, they would need to find other sources to
get the products.

Employees
This maybe for job security or increase in wages.
If employees are apart of the Employee Share Ownership Programme (ESOP).
To view the salary ratio of mgmt to lower level employees
To view the profitability of the entity.

Bank
To assess credit worthiness.
To determine payback potential of the borrwer.
To provide financial advice.

Government
For taxation reason.
To compile national statistics.
For nationalization.
To provide financial oversight or financial control.

Potential Investors
To check on profitability.
To weigh the options of investment.
To do risk assessment.
To make financial decision about a firm

Shareholders
To check the profit level of the firm.
To check the Return on capital employed(ROCE).
Make decisions about continuing or to sell their investment.

Trade Union
For verification of management’s word.
For bargaining powers at the bargaining table.
For comparisons of salaries

Financial Analyst
To make a financial report on the firm.
To highlight excellent performance.
To offer categorical awards.

Assignment – 1

BRIEF EXERCISE 1.1 on Users of Information

List Eight users of accounting information and explain their needs. The first Four is done for
you.
solution:
: user Need
1.Investors Those who want to invest money in an organisation want to know the
financial health of the organisation. They need accounting information
which will help them in evaluating past performance and future prospects
of the organisation.
2. Creditors : Creditors means supplier of goods and services on credit , banks and
lenders of money who want to know the financial position of a concern
before providing loans or granting credit. They need accounting
information relating to current assets, current assets and current liabilities
which is available in the financial statements.
3. Members Of Non Non-profit organisations such as hospitals, clubs,
Profit Organisations schools, colleges etc. need accounting information to know how their
contributed funds are being utilised. This information helps them to make
decision regarding future support.
4. Government Government wants to know earnings or sales for a particular period for the
purpose of taxation. Income tax returns are examples of financial reports
which are prepared with information taken from accounting.
5

3) Which of the following would be least considered as a user of accounting

information?

A. Trade Union representing the employees.

B. Other companies who supply goods on credit

C. An employee of another company who plans to invest his savings which is to be

received in ten years time.

D. Representatives of Television, Radio and Newspaper who provide financial

reports.
THE ACCOUNTING CYCLE
This is the cyclical process that is used to process accounting information. The accounting
cycle is a collective process of identifying, analyzing, and recording the accounting events of a
company. It is a standard 8-10 step process that begins when a transaction occurs and ends with
closing and opening entries after its financial statements.

The main purpose of the accounting cycle is to show the step by step layout of how we record
all the transactions systematically without missing an entry. This serves as a guide to
accountants to show the flow process of recording functions. It leads to the accuracy of all
financial records. The accountant prepares the financial statements
considering accounting records and cycle.
N.B.
Journalizing includes Sales Journal, Purchases Journal, Returns Outward Journal and Returns
Inward Journals.

Final Accounts includes Trading and Profit and Loss Account, Balance Sheet, Cash Flow and
Equity Statement.
Define and Describe the Initial 4 Steps in the Accounting Cycle

Solution:

First Four Steps in the Accounting Cycle

The first four steps in the accounting cycle are (1) identify and analyze transactions, (2) record
transactions to a journal, (3) post journal information to a ledger, and (4) prepare an unadjusted
trial balance. We begin by introducing the steps and their related documentation.
Accounting Cycle. The first four steps in the accounting cycle. (attribution: Copyright Rice
University, OpenStax, under CC BY-NC-SA 4.0 license)

These first four steps set the foundation for the recording process.

Step 1. Identifying and analyzing transactions is the first step in the process. This takes
information from original sources or activities and translates that information into usable
financial data. An original source is a traceable record of information that contributes to the
creation of a business transaction. For example, a sales invoice is considered an original source.
Activities would include paying an employee, selling products, providing a service, collecting
cash, borrowing money, and issuing stock to company owners. Once the original source has been
identified, the company will analyze the information to see how it influences financial records.

Let’s say that Mark Summers of Supreme Cleaners (from Why It Matters) provides cleaning
services to a customer. He generates an invoice for $200, the amount the customer owes, so he
can be paid for the service. This sales receipt contains information such as how much the
customer owes, payment terms, and dates. This sales receipt is an original source containing
financial information that creates a business transaction for the company.

Step 2. The second step in the process is recording transactions to a journal. This takes analyzed
data from step 1 and organizes it into a comprehensive record of every company transaction.
A transaction is a business activity or event that has an effect on financial information presented
on financial statements. The information to record a transaction comes from an original source.
A journal (also known as the book of original entry or general journal) is a record of all
transactions.

For example, in the previous transaction, Supreme Cleaners had the invoice for $200. Mark
Summers needs to record this $200 in his financial records. He needs to choose what accounts
represent this transaction, whether or not this transaction will increase or decreases the accounts,
and how that impacts the accounting equation before he can record the transaction in his journal.
He needs to do this process for every transaction occurring during the period.

(Figure) includes information such as the date of the transaction, the accounts required in the
journal entry, and columns for debits and credits.
General Journal. (attribution: Copyright Rice University, OpenStax, under CC BY-NC-SA 4.0
license)

Step 3. The third step in the process is posting journal information to a ledger. Posting takes all
transactions from the journal during a period and moves the information to a general ledger, or
ledger. As you’ve learned, account balances can be represented visually in the form of T-
accounts.

Returning to Supreme Cleaners, Mark identified the accounts needed to represent the $200 sale
and recorded them in his journal. He will then take the account information and move it to his
general ledger. All of the accounts he used during the period will be shown on the general ledger,
not only those accounts impacted by the $200 sale.
General Ledger in T-Account Form. (attribution: Copyright Rice University, OpenStax, under
CC BY-NC-SA 4.0 license)

Step 4. The fourth step in the process is to prepare an unadjusted trial balance. This step takes
information from the general ledger and transfers it onto a document showing all account
balances, and ensuring that debits and credits for the period balance (debit and credit totals are
equal).

Mark Summers from Supreme Cleaners needs to organize all of his accounts and their balances,
including the $200 sale, onto a trial balance. He also needs to ensure his debits and credits are
balanced at the culmination of this step.
Unadjusted Trial Balance. (attribution: Copyright Rice University, OpenStax, under CC BY-NC-
SA 4.0 license)

It is important to note that recording the entire process requires a strong attention to detail. Any
mistakes early on in the process can lead to incorrect reporting information on financial
statements. If this occurs, accountants may have to go all the way back to the beginning of the
process to find their error. Make sure that as you complete each step, you are careful and really
take the time to understand how to record information and why you are recording it. In the next
section, you will learn how the accounting equation is used to analyze transactions.
Forensic Accounting

Ever dream about working for the Federal Bureau of Investigation (FBI)? As a forensic
accountant, that dream might just be possible. A forensic accountant investigates financial
crimes, such as tax evasion, insider trading, and embezzlement, among other things. Forensic
accountants review financial records looking for clues to bring about charges against potential
criminals. They consider every part of the accounting cycle, including original source
documents, looking through journal entries, general ledgers, and financial statements. They may
even be asked to testify to their findings in a court of law.

To be a successful forensic accountant, one must be detailed, organized, and naturally


inquisitive. This position will need to retrace the steps a suspect may have taken to cover up
fraudulent financial activities. Understanding how a company operates can help identify
fraudulent activities that veer from the company’s position. Some of the best forensic
accountants have put away major criminals such as Al Capone, Bernie Madoff, Ken Lay, and
Ivan Boesky.
A tool that can be helpful to businesses looking for an easier way to view their accounting
processes is to have drillable financial statements. This feature can be found in several software
systems, allowing companies to go through the accounting cycle from transaction entry to
financial statement construction. Read this Journal of Accountancy column on drillable financial
statements to learn more.

Key Concepts and Summary

● Step 1 in the accounting cycle: Identifying and analyzing transactions requires a


company to take information from an original source, identify its purpose as a
financial transaction, and connect that information to an accounting equation.
● Step 2 in the accounting cycle: Recording transactions to a journal takes financial
information identified in the transaction and copies that information, using the
accounting equation, into a journal. The journal is a record of all transactions.
● Step 3 in the accounting cycle: Posting journal information to a ledger takes all
information transferred to the journal and posts it to a general ledger. The
general ledger in an accumulation of all accounts a company maintains and their
balances.
● Step 4 in the accounting cycle: Preparing an unadjusted trial balance requires
transfer of information from the general ledger (T-accounts) to an unadjusted trial
balance showing all account balances.
The full set of Financial Statements

Financial accounting generates the following general-purpose, external, financial statements:

1. Income statement (sometimes referred to as "results of operations" or "earnings


statement" or "profit and loss [P&L] statement")
Statement of comprehensive income.
2. Balance sheet (sometimes referred to as "statement of financial position")
3. Statement of cash flows (sometimes referred to as "cash flow statement")
4. Statement of stockholders' equity
5. Notes to the Financial Statement.
Income Statement
The income statement reports a company's profitability during a specified period of time. The
period of time could be one year, one month, three months, 13 weeks, or any other time interval
chosen by the company.

The main components of the income statement are revenues, expenses, gains, and losses.
Revenues include such things as sales, service revenues, and interest revenue. Expenses include
the cost of goods sold, operating expenses (such as salaries, rent, utilities, advertising), and
nonoperating expenses (such as interest expense). If a corporation's stock is publicly traded, the
earnings per share of its common stock are reported on the income statement. (You can learn
more about the income statement at Explanation of Income Statement.)
Statement of Comprehensive Income
The statement of comprehensive income covers the same period of time as the income statement,
and consists of two major sections:

● Net income (taken from the income statement)


● Other comprehensive income (adjustments involving foreign currency translation,
hedging, and postretirement benefits)
The sum of these two amounts is known as comprehensive income.
The amount of other comprehensive income is added/subtracted from the balance in the
stockholders' equity account Accumulated Other Comprehensive Income.
Balance Sheet
The balance sheet is organized into three parts: (1) assets, (2) liabilities, and (3) stockholders'
equity at a specified date (typically, this date is the last day of an accounting period).

The first section of the balance sheet reports the company's assets and includes such things as
cash, accounts receivable, inventory, prepaid insurance, buildings, and equipment. The next
section reports the company's liabilities; these are obligations that are due at the date of the
balance sheet and often include the word "payable" in their title (Notes Payable, Accounts
Payable, Wages Payable, and Interest Payable). The final section is stockholders' equity, defined
as the difference between the amount of assets and the amount of liabilities. (You can learn more
about the balance sheet at Explanation of Balance Sheet.)
Statement of Cash Flows
The statement of cash flows explains the change in a company's cash (and cash equivalents)
during the time interval indicated in the heading of the statement. The change is divided into
three parts: (1) operating activities, (2) investing activities, and (3) financing activities.

The operating activities section explains how a company's cash (and cash equivalents) have
changed due to operations. Investing activities refer to amounts spent or received in transactions
involving long-term assets. The financing activities section reports such things as cash received
through the issuance of long-term debt, the issuance of stock, or money spent to retire long-term
liabilities. (You can learn more about the statement of cash flows at Explanation of Cash Flow
Statement.)
Statement of Stockholders' Equity
The statement of stockholders' (or shareholders') equity lists the changes in stockholders' equity
for the same period as the income statement and the cash flow statement. The changes will
include items such as net income, other comprehensive income, dividends, the repurchase of
common stock, and the exercise of stock options.

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