1

CHAPTER

DPA101
Fundamentals of Accounting

CHAPTER 1
INTRODUCTION TO ACCOUNTING 1
 After completing this chapter, you should be able to
understand:

Define accounting and book-keeping

Describe accounting in qualitative characteristics, principles,
assumptions, and constraint according to accounting
framework and standards
Describe the roles of an accountant
Describe the functions of financial accounting
Describe the usage and the importance of accounting
information
Describe the types of business or entities
Purpose of a Business
Add Value Make a Profit

EBF 1013
SSSA
3
Business Goals and
Activities

Copyright2001 by Houghton
Mifflin Company. All rights
4 reserved.
 1-2

Objective
Objective 11

Define accounting and book-keeping

 Accounting Defined
is a
Accounting
Accounting Identifies
Identifies
system that

Records
Records

information
Relevant
Relevant Communicates
Communicates
that is

Reliable
Reliable
to
tohelp
help USERS
USERS
make
makebetter
better
Comparable
Comparable decisions.
decisions.
 Accounting Activities

Identifying Recording Communicating
Business Business Business
Transactions Activities Activities

Accounting - Language of Business

 Accounting Activities
Accounting is not an end in itself

Identifying Recording Communicating
Business Business Business
Activities Activities Activities

Keeping a Preparing
chronological log accounting
Selecting of transactions reports. Also
transactions and and events includes
events that are measured in analyzing &
relevant to Rupees and interpreting them
organization Classified & (to help Users in
Summarized in making better
useful format decisions)
 Definition of accounting and
book-keeping
Accounting is the process of identifying, recording,
summarizing and reporting economic information
to decision makers in the form of financial
statements.

Book-keeping is a process of recording data

relating to accounting transactions in the
accounting books.

EBF 1013
SSSA 9
Processing Accounting
Information
Accounting versus bookkeeping
Bookkeeping is the mechanical and repetitive
process of recording financial transactions and
keeping financial records.
Bookkeeping is a small part of accounting which
is recording of transactions.

Accounting is a comprehensive system for

collecting, analyzing and communicating financial
information
Accounting goals are the analysis, interpretation,
and use of information.
 1-2

Objective
Objective 22

Describe accounting in qualitative

characteristics, principles,
assumptions, and constraint
according to accounting framework
and standards
11
CONCEPTUAL FRAMEWORK

Objectives of Financial Reporting

Qualitative Elements of
Characteristics of Financial Statements
Accounting Information

Operating Guidelines

Assumptions Principles
Qualitative Characteristics of good
accounting information

An Introduction to Accounting 9/22/2010 13

CHARACTERISTICS OF USEFUL
INFORMATION
Generally Accepted Accounting Principles

Financial
FinancialAccounting
Accountingpractice
practiceisisgoverned
governedby
byconcepts
conceptsand
andrules
rules
known
knownasas Generally
GenerallyAccepted
AcceptedAccounting
Accounting
Principles
Principles(GAAP).
(GAAP).

Relevant
Relevant Affects
Affectsthethedecision
decisionof
of
Information
Information its
itsusers.
users.

Reliable
Reliable Information
Information Is
Istrusted
trustedby
by
users.
users.

Comparable
Comparable Is
Ishelpful
helpfulin
incontrasting
contrasting
Information
Information organizations.
organizations.
CONCEPTUAL FRAMEWORK

Objectives of Financial Reporting

Qualitative Elements of
Characteristics of Financial Statements
Accounting Information

Operating Guidelines

Assumptions Principles
 THE OPERATING GUIDELINES OF
ACCOUNTING
Operating guidelines are classified as
assumptions, principles, and constraints.
Assumptions provide a foundation for the accounting
process.
Principles indicate how transactions and other economic
events should be recorded.
Constraints on the accounting process allow for a
relaxation of the principles under certain circumstances.
Assumptions Principles Constraints
Monetary unit
Revenue recognition Materiality
Economic entity Matching Conservatism
Separate entity Full disclosure
Time period Cost

Going concern Objectivity

Dual aspect concept
 ASSUMPTIONS
USED IN ACCOUNTING
 MONETARY UNIT
ASSUMPTION

Only those transactions will be recorded which

can be measured in money terms.

19
 ECONOMIC
ENTITY
ASSUMPTION
Activities of the entity kept separate
and distinct from the activities of the owner
and all other economic entities.
Example: BMW activities can
be distinguished from those of
other car manufacturers such as
Mercedes.
 SEPARATE ENTITY
ASSUMPTION

For accounting purposes, entity of Owner is separate from entity of

Business
 TIME PERIOD
ASSUMPTION
Economic life of a business divided
into
artificial time periods.

2005 2006 2007

QTR 1 JAN FEB MAR
QTR 2 APR MAY JUN
QTR 3 JUL AUG SEPT
QTR 4 OCT NOV DEC
 GOING CONCERN
ASSUMPTION
Reflects assumption that the business will
continue in operation long enough to carry out
its existing objectivesinstead of being closed or
sold.
Implications: depreciation and amortization
are used, plant assets recorded at cost instead
of liquidation value, items are labeled as fixed
or long-term.
BASIC PRINCIPLES USED IN
ACCOUNTING
 PRINCIPLES
REVENUE RECOGNITION
STUDY OBJECTIVE 5

Revenue recognition principle

dictates that revenue should be
recognized in the accounting
period in which it is earned.
When a sale is involved, revenue is
recognized at the point of sale.
 MATCHING
(EXPENSE RECOGNITION)

Expense recognition is traditionally

tied to revenue recognition.
referred to as the matching
principle
dictates that expenses be matched
with revenues in the period in which
efforts are made to generate
revenues.
 MATCHING (EXPENSE RECOGNITION)
PRINCIPLE

Unexpired costs become expenses in two ways:

1) Cost of goods
merchandise inventory becomes expensed when
the inventory is sold
2) Operating expenses
other unexpired costs through use or
consumption or through the passage of time
 FULL DISCLOSURE
PRINCIPLE
Requires that circumstances and events that
make a difference to financial statement users
be disclosed.
Compliance with the full disclosure principle
1) data in the financial statements
2) notes that accompanying the statements
Summary of significant accounting policies
usually the first note to the financial
statements
 COST PRINCIPLE

The cost principle dictates that assets be

recorded on actual cost.
Cost is used because it is both relevant and
reliable.
1) Cost is relevant because it represents a)
the price paid, b) the assets sacrificed, or
c) the commitment made at the date of
acquisition.
2) Cost is reliable because it is a) objectively
measurable, b) factual, and c) verifiable.
 Dual aspect Concept
Principles

Every transaction has at least two effects and both of these

affects should be recorded.
It is applied to Accounting Equation
CONSTRAINTS IN ACCOUNTING

Two constraints
Materiality
relates to an items impact on a firms overall
financial condition and operations.
Conservatism
dictates that when in doubt, choose the method that
will be the least likely to overstate assets and income
CONSTRAINTS IN ACCOUNTING
 1-2

Objective
Objective 33

Describe the roles of an accountant

Roles
Roles of
of Accountants
Accountants

Financial accountants
prepare financial information
for external decision-making in
accordance with GAAP
Managerial accountants
prepare financial information
for internal decision-making
Roles
Roles of
of Accountants
Accountants

Auditors - evaluate controls

and attest to the fairness of the
financial statements.
Accounting managers -
control all accounting activities
of a firm.
Tax specialists - develop
information that reflects tax
obligations of the firm.
Consultants - devise
specifications for the AIS.
 1-2

Objective
Objective 44

Describe the functions of

financial accounting

36
Functions of Financial Accounting
1. Recording of information
2. Classification of data .
3. Making summaries
4. Dealing with financial transactions .
5. Interpreting financial information .
6. Communicating results
7. Making information more reliable .
 1-2

Objective
Objective 55

Describe the usage and the importance

of accounting information
 Accounting as an Information
System

Information needs of management : management

needs information for planning, organizing & controlling
the activities of business. The supply of information at
appropriate time help management in achieving the
business objectives
Information needs of shareholders & Investors :

various laws have been passed under which financial

statements should be prepared in such a way that
required information is supplied to the shareholders &
creditors
Information needs of employees: accounting

information is required for deciding workers share in

profits, setting wages disputes, etc.
 Information needs of creditors : Creditors
are mainly interested in creditworthiness of
the business. They need information about
liquidity position of the company. So they will
study information concerning solvency,
liquidity, & profitability of the business.
Information Needs of Government : Govt.

needs information about sales, profits,

liquidity, dividend policy etc.The information
helps the govt. in deciding the social &
economic policies.
 Accounting as an information system

Accounting Decision
making

Data
Processing of Communication
Recording
Business data (as financial
of data
activities & (preparation Statements &
(measuring
transactions and storage other
business
of data Statements &
transactions
reports)
Users of Accounting Information

Internal Users External Users

Those directly Those not directly
involved in involved in managing
managing and and operating an
operating an organization
organization
Users of Accounting Information
Accounting information helps users both internal and external to
make better decisions

Internal Users External Users

Directors Owner/Shareholders
Managers Creditors/ Lenders
Officers/employees Customers
Budget Officers Investors
Internal Auditors External Auditors
Brokers/Financial Analyst
Financial Advisors
 Accounting
Users with indirect
Users with
financial interest:
direct financial
(customers, taxation
interest:
authorities, financial
Management: (Present and
analysts and advisors,
(directors, officers potential
brokers, labor unions,
of the company, shareholders,
consumer group general
managers, dept. creditors,
public, press etc.)
heads and employees,
Decisions:
supervisors) suppliers)
Assessing tax, protecting
Decisions: Decisions:
investors and public
Assessing Share investment
interest advising on
profitability, decision, credit
investment decisions,
financial decisions,
setting economic policies,
performance in assessing
measuring social and
terms of plans & company status
environmental protection
goals, marking and prospects,
programmed, negotiation
plans and policies approving supply
labor agreements.
decisions
Questions Asked by
Internal Users
Iscash sufficient to pay bills?
What is the cost of

manufacturing each unit of

product?
Can we afford to give employee

pay raises this year?

What product line is most

profitable?
Prentice Hall, Inc. 2000 45
Questions Asked by
External Users
Is the company earning
satisfactory income?
How does the company compare

in size and profitability with

competitors?
Will the company be able to pay

its debts when they become

due?
Prentice Hall, Inc. 2000 46
 Objective
Objective 55
Describe the types of business
and forms of business
organization

47
Types of Business
Service Businesses provide service rather
than product to customers. Example?
Merchandising business sell products they

purchase from other businesses to

customers
Examples?
Manufacturing Business change basic inputs

into products that are sold to customers

Examples?

EBF 1013
SSSA 48
1.5.2 Types of Business

Service
ServiceBusiness
Business Service
Service
Les
LesCopaque
Copaque Entertainment
Entertainment
Malaysia
MalaysiaAirlines
AirlinesSystem
System(MAS)
(MAS) Transportation
Transportation
Maybank
MaybankCorporation
Corporation Financial
Financialservices
services
Seri
SeriMalaysia
Malaysia Hospitality
Hospitalityand
and
lodging
lodging
PWC
PWC Auditing
Auditing

49
1.5.2 Types of Business contd

Merchandising
Merchandising Business
Business Product
Product
Giant
Giant General
Generalmerchandise
merchandise
Amazon.com
Amazon.com Internet
Internetbooks,
books,music,
music,video
video
Toy
ToyR
RUs
Us Toys
Toys
Pensonic
Pensonic Consumer
Consumerelectronics
electronics
Cheetah
Cheetah Apparel
Apparel

50
Types of Businesscontd

Manufacturing
Manufacturing Business
Business Product
Product
General
GeneralMotors
MotorsCorporation
Corporation Cars,
Cars,trucks,
trucks,vans
vans
Nokia
Nokia Cell
Cellphones
phones
Acer
Acer Personal
Personalcomputers
computers
Adidas
Adidas Athletic
Athleticshoes
shoesand
andapparel
apparel
FF&&NNCompany
Company Beverages
Beverages
Samsung
Samsung Stereos
Stereosandandtelevisions
televisions

51
Types of Business Activity
1. Services
- could be in the form of proprietorship,
partnership or corporation
2. Manufacturing
- usually in the form of corporation
3. Merchandising
- buying of goods to be sold back
Forms of Business

53
Sole-Proprietorship

Sole proprietorship is a one-man business, owned and

managed by one person,

more than 70% of business organizations in

Malaysia are organized by proprietorships,

easy and low cost of organizing,

financial resources are limited to the owners

resources, and

commonly used by small businesses such as

hardware stores, laundries, restaurants, and grocery
shop.
54
Sole-Proprietorship

Advantages
1. Ease of formation.
2. Low cost of formation.
3. No requirement for auditing by a public accountant.
4. Lower tax on profit.

Disadvantages
5. Unlimited liability of owner.
6. Difficult to obtain external finance.
7. Lack of support by external parties.
8. Transfer of ownership is difficult.

55
Partnership

Partnership is a business formed by two people but having

not more than 20 partners. Professional partnership can
have a maximum of 50 members.

about 10% of business organizations in Malaysia

are organized by partnerships,

combine the skills and resources of more than one

person, and

like proprietorships, small local businesses such

as automotive repair shops, music stores, beauty
salons, and clothing stores may be organized as
partnerships.
56
Partnership
Advantages
1. Ease of formation.
2. Low cost of formation.
3. Combined experience and managerial skills of partners.
4. Less government regulations (e.g.: to engage public accountant).
5. Lower tax burden (only income tax).
6. Shared control

Disadvantages
7. Limited life
8. Unlimited liability
9. Transfer of ownership is difficult
10. Difference in opinion among partners (e,g,: the extent of liability of partners)
11. Difficult to transfer ownership.
12. Difficult to raise funds for expansion and investment.
13. Changes in partnership agreement leads to partnership to be resolved.

57
Limited Liability Company

combines attributes of a partnership and a

corporation in that it is organized as a corporation.

a company is an enterprise formed by two or more

persons with a maximum of 50 people for a private
limited company and no maximum limit for a public
limited company.

can elect to be taxed as a partnership

a popular alternative to a partnership

has tax and liability advantages to the owners.

58
Limited Liability Company
Advantages
1. Limited liability for shareholders.
2. Ease of transferring ownership.
3. Continuous existence.
4. No mutual agency.
5. Professional management.
6. Ease of capital assembly.
7. Private limited companies may become public companies.

Disadvantages
8. High cost of formation.
9. Higher overhead on accounting and secretarial disclosure.
10. Tighter government regulation and more extensive public
disclosure.
11. Separation of ownership and control makes it difficult for
shareholders to take action on bad management group.

59
Grading
Grades are what you make of them. Not
what they make of you, unless YOU made it
that way!

A Not F
End of Chapter 1