Introduction to accounting

Chapter objectives
After studying this unit , you should be able to :
 Explain the meaning of accounting
 Identify the users and users of accounting
 Explain the various branches in the profession of accounting
 Explain the meaning of ‘generally accepted accounting principles’
 Explain the meaning of business entity assumption ,cost principle ,and monetary unit
assumption
 State the basic accounting equation and explain the meaning of assets, liabilities ,
and owner’s equity
 Analyse the affects of business transaction on the basic accounting equation and,
 Prepare an income statement , owner’s equity statement ,and balance sheet .

Introduction
We life in the information age time of communication and a time when information is a vital
resource. In this information era .how we life ,whom we associate with ,and the
opportunities we have all depend on our access to and understanding information .
The same is true for business(business are one or more individual selling products or service
for profit) business that have better access to information and that process information
more quickly And Accurately do the best ,Global computer networks and
telecommunications equipment now allow us to get access to all types of business
information. But to take advantage of these ,we need knowledge of information systems.
An information system is the collecting ,processing and reporting of information to decision
makers ,understanding and processing information is the core of accounting
The kind of information processed in accounting is financial I.e of a monetary nature
providing information about what business own ,what they owe ,and how they perform is
the aim of accounting ,accounting is an information and measurement system that identifies
records and communicates relevant ,reliable and comparable information about an
organization ‘s(a business’s)economic activities
Therefore ,a study of accounting helps people make better and informed decisions about
assessing opportunities ,products, investments, and social and community responsibilities.
But the use of accounting information is not limited to accountants or people in business .
you can use accounting information to get a loan for a house or to start a new business . the
study of accounting therefore ,opens you new and exciting possibilities both in terms of
accounting a professional accountant and using accounting information in your daily life .
This course discusses fundamental principles involved in processing accounting information
of business enterprises , understanding these fundamental principles is very important
because forthcoming courses that you are going to take in accounting will build on these
principles .

DEFINITION ,IMPORTANCE AND USERS OF ACCOUNTING INFORMATION

ACCOUNTING DEFINED
As a financial information system , accounting is defined as a process of
identifying ,measuring ,recording and communicating economic events of an organization
(business or non-business) to interested users of information
Lets take a closer at the activities involved in the process:
1) The first part of the process –identifying –involves selecting those events they are
considered evidence of economic activity relevant to a particular organization , the
sale of goods by Hadiya super market , the rendering of service by Ethiopian
telecommunication corporation , the payment of salary by commercial bank of
Ethiopia , and the purpose of building by unity university collage are examples of
economic events
2) Once identified and measured in Birr and Cents , economic events are recorded to
provide a permanent history of the financial activities of the organization ,recording
consists of a keeping a chronological diary of measured events ,in an orderly and
systematic manner , in recording ,economic events are also classified and
summarized ( this will be discussed in detail in unit -2)
3) This identifying and recording activity is of little use unless the information is
communicated to interested users , the information is communicated through the
preparation and distribution of accounting reports , the most common of which are
called (financial statement)
A vital element is communicating economic events is the accountant’s ability and
responsibility to analyse and interpret the reported information ,analysis involves the use of
ratios ,percentages ,graphs and charts to show the importance of financial trends and
relationships ,interpretation involves explaining to the user the meaning and limitation of
reported data , the analysis and interpretation part is left for advanced courses in
accounting .
As a accounting plays an important role in the decision making process of business entities ,
is often called the language of business , as a result whether you are an economist , a
marketer ,investor ,supplier or any other , to be successful you should be able to speak and
be familiar with the basic terms used in the business environment.
Importance of accounting and users of accounting information
Importance of accounting
The main purpose of accounting is to provide financial information to be used for decision –
making , for instance business executives and managers need the financial information
provided by the accounting system to help them plan and control the activities of the
business outsiders such as bankers ,potential investors and Labor unions and other also
need accounting information , in short the goal of the accounting system is to provide useful
information to decision makers. Thus accounting is the connecting link between decision
makers and business operations.

Bookkeeping Versus Accounting

People often fail to understand the difference between bookkeeping and accounting ,
Bookkeeping is the process of recording business activities ,and keeping the records ,it is the
record -making phase of accounting .the recording of transactions in bookkeeping tends to
be mathematical and repetitive ; it is only a small and probably the simplest but important
part of accounting.
Accounting on the hand includes the design of information system that meets user’s needs .
the major goals of accounting includes system design, budgeting ,cost analysis, auditing and
tax planning and preparation .
A person might become a reasonably , proficient bookkeeper in a few weeks or month’s
however to become a professional accountant acquires several years of study and
experience.

Users of accounting information

Today’s accountants focus on the ultimate need of those who use accounting
information ,whether the users are insiders or outside the business, accounting is not an
end by it’s self . the information that accounting provides allows users to make reasonable
choices among alternative uses of scarce resources in the conduct of business’
The people who use accounting information basically fall in to two categories :
1) External users , and
2) Internal users
 External users: external users of accounting information are parties ; which are
not directly involving in running the business enterprises .these include lenders,
shareholders(stockholders),suppliers, employees, and their
unions ,government(regulatory bodies ) and others , external users rely (depend
on)accounting information to help them make better decision in trying to achieve
their goals .
 -the area of accounting aimed at serving external users is called financial
accounting ,it is main objective is to provide to external users information through
financial statements
Each external users has it’s own specified information depending up on the decision to be
made .that is to say ,all external users do not have the same intentions (objectives ) when
they use the information ,in the following paragraphs we will try to discuss how some
external users use accounting information
a) LENDERS/CREDITORS
Creditors lend money or other resources to an organization , lenders include
bankers ,mortgage and finance companies ,lenders look for information to help them assess
the ability of borrowers to repay their debts.
b) SHAREHOLDERS (stockholders)
Shareholders have legal control over part or all of a corporation .when it comes to
corporation , shareholders are not directly involved in the management of the
corporation .however as owners they have claim over the properties of the
organization ,financial reports help to answer shareholder’s questions such as :
-what is the income of an organization for the current and past periods?
-are the properties adequate to meet use ness plan ?
-will the business continue to be profitable in the future?
c) EMPLOYEES AND LABOR UNIONS
Employees and Labor unions are interested in judged the fairness of their wages and
assessing future job prospects .they also use accounting reports as a evidence to ask for
bonuses ,when the organization is a successful .
d) GOVERNMENT
The inland revenue authority requires organizations to prepare financial reports , in order t
compute taxes

 Internal users : these are persons that are directly involved in managing and
operating in organization ,they include managers and other important decision
makers , the internal role of accounting is to provide information to help improve the
efficiency and effectiveness of an organization .
-the area of accounting aimed at serving the decision making needs of internal users
is called management accounting .internal users often have access to a lot of private
and valuable information . internal reports aim to answer question like:
-what are manufacturing costs per products ?
-which service activities are most profitable?
-what level of sales is necessary to break even?

THE ACCOUNTING PROFFESSION

If you just joined the accounting profession ,you may be wondering what job you will be
doing in the future , you probably would apply your expertise in one of three major fields :
-private accounting
-public accounting
-not for –profit accounting

I. Public accounting
In public accounting you would offer expert service to the general public in much the same
way that a doctor serves patients and lawyer service clients , a major portion of public
accounting practise is involved with auditing . in this area a certified public accountant (CPA)
examines the financial statements of companies and expresses opinion as to the fairness
of presentation ,when presentation is fair ,users consider the statements to be reliable
Management consulting is another area of public accounting .in this case accountant
consults the managements generally about the growth and development of the business
enterprise

II. Private accounting

Instead of working in public accounting ,an accountant may be employee f a business
enterprise ,in private accounting , you would be involved I one of the following activities :
1) COST ACCOUNTING : determines the cost of producing specific products
2) BUDGETING: assisting management in quantifying goals concerning revenues ,cost of
goods sold, and operating expenses
3) GENERAL ACCOUNTING: recording daily transactions and preparing financial
statements and related information
4) ACCOUNTING INFORMATION SYSTEMS: designing both manual and computerized
data processing systems
5) TAX ACCOUNTING: preparing tax returns (- forms to be filled by a company and
returned to a taxing authority ) and engaging in tax planning for the company.
6) INTERNA AUDITING: reviewing a companies operations to determine compliance
with management policies and evaluating efficiency operations
III. Not for profit accounting
Like a business that exists to make a profit , not for –profit organizations also need sound
financial reporting and control ,donors to such organizations want information about how
well the organization has met it’s objectives and whether continued support is justified , in
each of these cases accounting expertise is highly valued.
Accounting principles and concepts
Accounting ,as it’s true for other disciplines has got it’s own principles and practises , one
must be able to understand these principles and practises to understand and prepare
financial statements and reports ,the principles and concepts used in accounting are called
(GAAP) generally accepted accounting principles these principles guide accountants how to
record and reports business activities ,however currently the world is shifting from using
GAAP to IFRS(international financial reporting standard)
IFRS/GAAP are developed over a long span over a years by accounting profession . that is
their development is not revolutionary , the main purpose of basic rules is to guide
accountant in measuring and reporting financial events of business enterprises
GAAAP/IFRS are not like un change by laws of nature found in biology and chemistry . they
can be changed as a better method are developed or as circumstances change . generally it
is from research and pronouncements of professional bodies that GAAP/IFRS evolve.
In this unit we will discuss three of the generally accepted accounting principles , business
entity concepts ,cost principle ,and monetary unit assumption

i. Business entity concept

Accountants frequently refer to a business organization as an accounting or business entity ,
a business entity is any business organization such as a supermarket , laundry ,barberry or
a hotel , which exist as an economic units , for accounting purposes .each business
enterprise has a separate existence from it’s owners ,creditors .employees ,customers and
other businesses.
This separate existence of the business enterprise is known as a business entity
concept .thus the business entity should have a completely separate set of records and it’s
financial records and reports should refer only about the business enterprises
For example W/o Muna Mamo has got her own two business enterprises one called
munaye super market and another hotel called Budena hotel , each business would be
considered as an independent business unit . the activities of each business are kept
separately from each other and from the owners personal records . let say W/o
muna bought a house to life in , this house would not be recorded and reported in the
records of either the supermarket or the hotel , the personal saving account she has will not
as well be included in the financial reports of either one of the businesses , she must have to
open separate bank accounts for two businesses . the supermarket should not record the
payment of salary to employees of the hotel
According to IFRS , this concept is called ECONOMIC ENTITY ASSUMPTION with the same
concept explained for GAAP.
ii. The cost principle
The cost principle states ‘properties and services acquired by business enterprises must be
recorded at actual amounts paid or assumed in acquiring the properties’
For example .modern advertising company is considering the purchase of a building , the
seller of the building offers a price of birr 10,000 while the buyer first offered price of birr
8,000 , however after certain bargaining, the seller agreed to sell the building for birr 9,000
and the buyer paid the amount , according to the cost principal the buyer has to record the
building in it’s records at birr 9,000 – the actual amount paid to get the building .the buyer
may receive an offer of birr 12,000 for the building a month after it has been acquired , this
has no effect on the accounting records because it doesn’t originate from an actual
exchange , it’s simply a mere offer
If the buyer sells the building for birr 20,000 after purchasing it , again of birr 11,000 would
be realized , the newer owner would use birr 20,000 as the cost of the building .
In an exchange between a buyer and a seller both attempts to get the best price , only
amounts agreed up on and paid are objective enough for accounting purposes .
Accounting to IFRS this principle is called measurement principle which entailed Historical
Cost measurement with the same concept explained for GAAP under cost principle , and Fair
Value measurement which is defined as the price that would be received to sell an asset or
paid to transfer a liability in an orderly transaction between market participants at the
measurement date

Monetary assumption
All business activities (events) are record in terms of money (-Birr , Dollar, Pound or any
other currency )of course information of a non-financial nature can be recorded , but it’s
only through the recording of Dollar ( Birr) amounts that business activities of a business can
be measured , money is the only factor common of all business activities , Therefore is the
only practical unit of measurement that can produce financial data can be compared ,
The monetary unit used by a business depend on the country in which it exists , for example
in Ethiopia the basic unit of the measurement is the Birr as it is Dollar in USA , and Pound
sterling in UK ,according to IFRS , the same nomenclature and concept is used for this
assumption

Monetary unit assumption

There are three basic forms of business organizations ,sole proprietorship, partnership ,and
corporations ,accounts recognize each from as an economic unit separate from it’s owners
(Business entity Concept).
In this course , we will begin by the accounting for sole proprietorship because is the
simplest form of accounting.
1) Sole proprietorship
A sole proprietorship is a business owned by one person and usually managed by the one
owner no special legal requirements must be met to start a sole proprietorship and usually
only a limited investment is required to begin operations.
A sole proprietorship is a separate entity for accounting purposes (Business entity concept)
but it’s not separate legal entity from the owners ,that is from the legal point of view the
owner and the business owner are treated as one and the same .the owner will be held
personally responsible for debts and actions of the business
For instance assume flower laundry is a sole proprietorship owned by Ato Alemu , assume
also that a business has borrowed Birr 10,000 from the commercial Bank of Ethiopia and
failed to pay it’s debts , in this case if the commercial bank of Ethiopia can’t recover the
amount it lent from the properties of the company it can go to the extent of selling the
owner’s personal properties .
2) Partnership
A partnership is alike sole proprietorship in most way except that 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 owner of the
partnership is known as partners.
The partners share the profits and losses of the partnership according to a agreed on
formula , the personal resources for each partner can be called on to pay obligations of the
partnership . that is each partner is personally responsible for the debts of the partnership,
from the accounting stand point ,however, a partnership is a business entity separate from
the personal activities of the partners.
3) Corporations
A business organized a separate legal entity with ownership divided into transferable units
of capital is called a corporation ,the owners of a corporation is called stockholders or
shareholders. the corporation issues capital stock certificates to each stockholder showing
the number of shares (or stock) her or she owns , the stockholders are free for sell all or part
of these shares to other investors at any time. this case of transfer of ownership adds to the
attractiveness of investing in corporation , since corporation is a legal entity the owners
(shareholders) are not personally liable for the debts of corporation , their risk of loss is
limited to the amount they paid (invested) because of limited liability in a corporation
shareholders are willing to invest in riskier but potentially more profitable , activities.
Even through corporation are fewer in a number than proprietorship and partnership , they
contribute a lot to the economies of many countries in monetary terms.

BUSINESS TRANSACTIONS AND THE ACCOUNTING EQUATION

Business transactions are economic events that should be recorded because they affect the
financial position of the business enterprise , these business transactions are the raw
materials of accounting reports ,as a cotton is a raw material for a textile factory .
A transaction can be exchange(such as the purchase or sale of property ,payment or
collection of loan etc) between two or more properties . a transaction can also be an event
has the same effect as an exchange transactions but does’ not involve an exchange
transaction.
Some example of ‘non-exchange’ transactions are losses from fire, flood, physical wear on
equipment ,donation of property and so forth
For a given transaction to qualify to be recorded it has:
1.to be related to the business enterprise
2.to be measurable in terms of money
3.to be completed / happened / action
(I.e it should not be a mere promise or intention ; it must be at least partially completed to
be recorded )
Asset, liability, and owner’s equity
If you have noticed in any organization you will find properties such as a
building ,furniture ,land ,vehicles and the like , such properties owned by business
enterprise are referred to as Asset , to buy these assets business get money from two
sources ; investment made by owners or amount borrowed from creditors .therefore both
owners and creditors have a claim over asset of the business enterprise , the claim or the
right of owner’s are referred as Equities , if the asset owned by a business amount to Birr
50,000 the equities in the assets must also amount to Birr 50,000 the relationship between
the two may be stated in the form of an equation ,as follows:

Economic resources =claims over the resources

Asset=equities
Equities may be subdivided in to two principle types ; the rights of creditors and the right of
owners ,the right of creditors represent debts of the business and are called liabilities .the
rights of owners are called owner’s equity (capital)
Asset=equities
Equities =liability + owner’s equity
The equation can be written as :
Asset =liability + owner’s equity
It is the customer’s to place ‘liabilities ‘ before’ owner’s equity ‘ in the accounting equation
because creditors have priority (preferential) rights to the assets , because of this ,the
owners have residual claim over the assets, to help you to understand this ,assume X
company has total asset of Birr 5,000 liabilities of Br 2000 and owner’s equity of Br 3000 , if
the business is to be closed the asset of the company will be sold and distributed to the
claimants , in the accounting , the owner’s are given their share after the creditors are given
their entire share for example .assume the asset are sold for Br 4,500 the creditors will be
given their share of Birr 2000 and whatever remained Br 2,500) is given to the owners , if
the assets were sold for Birr 7,000 the creditors would have been given their share of Br
2000 and the remaining balance Br 5000 would have been given to the owners
As you can notice the owners are given what ever is left 9 it could be greater or less than
their share ) that is why we said owners have residual claim over the asset of the business
whereas creditors are said to have priority calm over the asset as they are paid first

Transactions and the accounting equation

All the business transactions from the simplest to the complex can be stated in terms of the
resulting effects on the three basic elements of the accounting equation , however it is
important to remember that each transaction leaves the equation in balance , asset always
equal the sum of liabilities and owner’s equity
Lets examine the effects of some of the most common business transactions on the
accounting equation as a means of illustration suppose Ato Dawit Gemechu, establishes a
sole proprietorship to be know as Effective Garage , on September 1 .200X during
September , the business engages in the following transactions :

Transaction (1)-owner’s investment

Ato Dawit starts business by depositing Br 100,000 in a bank account opened in the name of
effective Garage , the transfer of cash from the owner to the business is on owner’s
investment , the effect of transaction is to increase the asset (cash) on the left side of the
accounting equation by Birr 100,000 and to increase owner’s equity by the same amount .
Asset = liability + 0wner’s equity
Cash Dawet gemechu ,capital
Trans.1+Br 100,000 +Birr 100,000
Balance Br 100,000 Br 100,000
At this point the company has no liabilities ; the only part having claim over the assets of the
company is the owner .
N.B the equation relates only to the business enterprise . ato Dawit’s personal assets such
as his home and personal Bank account and personal liabilities are excluded from
consideration
The business must be treated as a separate entity.

Transaction (2)-purchase of land for cash

Effective garage bought land for Birr 20,000 in cash to be used as a future site for the
business ,this transaction changes the composition of the asset but it doesn’t change the
total amount of assets , it has n o effects on the liability and owner’s equity of the business.
Asset =liabilities + owner’s equity
Cash + land Dawet Gemechu,capital
Bal.Birr 100,000 Birr 100,000
Tran.2 -20,000 +20,000
Bal,Birr 80,000 + 20,000 = 100,000
After the above transaction , the company will have less cash but a new asset (land) , the
total asset (cash + land ) amount to Birr 100,000 which is equal to the owner’s equity.
Transaction (3)-purchase on credit
Ato Dawit bought office supplies for Birr 2,500 on credit to be used by the business ,assets
can be purchased on credit ( on account) basis where the buyer promises to pay in the
future , this type of transaction is called a purchase on account and it results in a liability to
the buyer : the liability created when something is bought on credit is called Account
payable

Asset =liability + owner’s equity

Cash + supplies + land account payable D.Gem,capital
Bal, birr 80,000 20,000 Br 100,000
Tran(3)__________+2.500 +2.500
Bal.br 80,000 2.500 20,000 2.500 100,000
Birr 102,500 Birr 102,500
Goods that are physical consumed ,such as chalk to a school , gas oil for car ,and stationery
materials for an office are called Supplies

Transaction (4)-payment of liability

Effective Garage paid Birr 1,500 to creditors on account as you might have noticed the
business bought the supplies in transaction ‘C’ by promising to pay in the future and as per
the promise made it is now settling it’s liability, the effects of this transaction on the account
equation is as follow as :
Asset =liabilities + O.E
Cash + supplies + land Account payable D.gem,capital
Bal,br 80,000 2,500 20,000 Br 2,000 Birr 100,000
Tran4 -1,500 -1,500
Bal Br 78,500 Br 2,500 Br 20,000 Birr 100,000
Birr 101,000 Birr 101,000
As the result of transaction , the total cash decreased by Birr 1,500 because cash is paid and
the liability of the company also decreased by the same amount . after the above
transaction is completed the total amount the company has to pay in the future is only Birr
1,000 ,please note that the transaction has no effect on the supplies that were bought on
credit.
Transaction 5 –selling of service
The amount charged to customers for goods or services sold to them is called Revenue , for
instance the amount of money that to pay to a shopkeeper after buying a pair of shoes or
something is revenue to the shopkeeper , different titles may be used for revenue
depending up on the source of revenue , for example , a service fee for a garage , interested
revenue for interest earned by a Bank ,rent income for a revenues that result from renting
rooms ,fares earned for revenues from a taxi service and others.
During the first month of operation ,effective garage earned service fees of Birr 30,000
receiving the amount in cash for the garage service it rendered .
The effect of this transaction is to increase assets ( because cash is collected ) and to
increase owner’s equity by the same amount as revenue is earned .
Assets =liability + owner’s equity
Cash + supplies + land account payable Dwit,gem,capit
Bal.Br 78,500 2,500 20,000 1,000 100,000
30,000 30,000
Bal,Br 108,500 2,500 20,000 1,000 130,000
BIRR 131,000 BIRR 131,000
Service can be given for cash or on credit , in this example , the service is given for cash (I.e
the company collects the cash on the post service was given ). But instead of requiring
customers to pay at time of sale , a business may le the customers to pay in the future ,
such expected collections in the future result in an Accounts receivable to the company an
accounts receivable is as much an asset as a cash to a business enterprise , and the revenue
from the sale of the service or goods on credit is realized and recorded on the date of sale
with out waiting for the collection of the cash.

Transaction 6 –Recording Expenses

To generate revenue , effective garage has to hire employees and pay salary , it has to
consume electric power and water resource and pay the bill ,and so forth , the amounts of
such cash payment And using up of supplies are Expenses to the business, that is an expense
is the amount of asset consumed or services used in the process of generating revenue , just
as a revenue are recorded when they are earned ,expenses are recorded when they are
incurred (I.e when the obligation to pay them arises).
During the month of September , effective garage paid Birr 15,000 for different types of
expenses (birr 10,000) to salary of employees , birr 3,000 telephone , birr 1,500 for rent and
birr 500 for advertisement)
The effect of these transactions is to decrease asset ( because cash is paid ) and decrease
owner’s equity . this can be stated on the accounting equation as follows:
Asset =liability + owner’s equity
Cash + supplies + land A/P Dawett,gem,capital
Bal,Br 108,500 2,500 20,000 1,000 130,000
-15,000 -15,000
Bal,Br 93,500 2,500 20,000 1,000 115,000

BIRR 116,000 BIRR 116,000

Transaction 7 – owner’s withdrawal
Ato dawit gemechu , the owner , withdrew Birr 3000 for his personal from the business,
such asset taken out of the business for the owner’s personal use , by the owner are called
withdrawals owners can withdraw in cash or in kind , for example an owner of a
supermarket can withdraw soap or something for his personal benefit instead of cash.
The effect of the transaction in our case is to decrease asset as cash is taken out , and
decrease owner’s equity by the same amount this can be stated on the accounting
equation as follows
Asset =liability + owner’s equity
Cash + supplies + land account payable Dawet,Gem,cp
Bal,Br 93,500 2,500 20,000 1,000 115,000
-3,000 -3,000
Bal,Br 90,500 2,500 20,000 1,000 112,000
BIRR 113,000 BIRR 113,000
Summary
The transaction of effective garage can be summarized in a tabular from as show below .
number identifies the transaction here and the balance of each item is shown after each
transaction.
Asset =liability + owner’s equity

Tra cash supplies land Account Dawet,gem Types of

No payable capital owner’s
transaction
1 100,000 +100,000 Owners
investment
Bal 100,000 100,000
2 -20,000 +20,000
Bal 80,000 20,000 100,000
3 +2,500 +2500
Bal 80,000 2,500 20,000 2,500 100,000
4 -1,500 -1,500
Bal 78,500 2,500 20,000 1000 100,000
5 +30,000 +30,000 Service fee
Bal 108,500 2,500 20,000 1,000 100,000
6 -15,000 -10,000 Salary Exp
-30,000 Telph Exp
-1500 Rent Exp
-500 Adv,Exp
Bal 93,500 2,500 20,000 1000 115,000
7 -3,000 -3,000 Owner’s
withdrawal
Bal 90,500 2,500 20,000 1000 112,000
Total asset=Birr 113,000 Total liabilities and owner’s equity=Birr
113,000

The following observations , which apply to all types of businesses should be noted :
1.the effect of every transaction can be stated in terms of increases and / or decrease in one
or more of the elements of the accounting equation .
2.the equality of the two sides of the accounting equation is always maintained
3. the owner’s investment and revenues increase the owner’s equity , withdrawals and
expenses during the period decrease the owner’s equity , the effects of these four types of
transactions on owner’s equity can be illustrated as follows:
 Owner’s equity

Decrease by: Increase by:

Owner’s withdrawals Owner’s investment and

and expenses revenues

The relationship of the above elements and their effect on the capital balance can be shown
as:
EC=BC+I-W+R-E
Where EC-end capital balance
BC-beginning capital balance
I-owner’s investment
W-owner’s withdrawals
R-revenue
E-expense

Financial statements of sale proprietorship

After the effect of the individual transaction has been determined , the essential
information is communicated to users at a 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 .
The major financial statements used to communicate accounting information about a
business are :
-income statement
-balance sheet
-statement of owner’s equity
-statement of cash flows (will be discussed in senior courses)
Since these financial statements are in a sense the end products of the accounting process ,
a student who acquires a clear understanding of the content and meaning of financial
statements will be in an excellent position to be appropriate the purpose of the earlier steps
of recording and classifying business transactions
The income statement
The income statement is the financial statement that summarizes the amounts 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 month or a year , in accounting profitability is measured for a period of time than
on a daily basis , through measuring daily could be possible , it will not be practical and
benfitial to the business enterprise .
If the revenue of a period exceeds the expenses of the same period , net income results , if
the expenses are greater than the revenues of the period ,we say the is a net loss , that is ,
the business has operated unprofitably .
N.B the determination of the periodic net income (net loss) is a matching process involving
two steps ,first revenue earned are recognized during the period , second the expenses
incurred to generate revenues are matched (compared ) against revenues to determine net
income or net loss.
All financial statements have a heading that you can find in any kind of report , the heading
of these statements identifies the company , the types of the statement, and the time
period covered by the statement . note that the primary focus of the income statement is
reporting the success or profitability of the company’s operations over a specified period of
time , to indicate that it is applies for a period of time , the income statement is dated ;for
the month ended ‘….
The following is an income statement for effective garage for the month ended September
30.200X

Effective Garage
Income statement
For the month ended September 30,200X

Revenues :

Service fee Birr 30,000

Expenses:

Salary expense Birr 10,000

Telephone expense 3,000

Rent expense 1,500

Advertising expense 500

Total expenses 15,000

 According to IFRS , this statement is known as Statement of comprehensive income which
comprises an income statement displaying components of profit or loss and a statement of
a comprehensive income that begins with profit or loss (bottom line of the income
statement) and displays the items of the other comprehensive income for the reporting
period where comprehensive income is the change in equity (net asset ) of a business
enterprise during a period from transactions and other events and circumstances from non-
owner sources .the statement of comprehensive income illustrates the financial
performance and results of a operations of a particular company or entity for a period of
time.
Owner’s equity statement
This is the statement that summarizes the changes in owner’s equity for a specific period of
time .data for the preparation of owner’s equity statement are obtained from owner’s
equity column of the tabular summary (illustration 1-) and from the income statement . the
heading of this statement identifies the company , the types of statement ,and the time
period covered by the statement , the time period is the same as that covered by the
income statement and therefore is dated ‘for the month ended September 30,200 X’ the
beginning owner’s equity amount is shown on the first line of statement , then the owner’s
statement , net income and owner’s drawings are identified in the statement, the
information provided by this statement indicates the reasons why owner’s equity has
increased or decreased during the period .the owner’s equity statement for effective
Garage for the month of September is shown below:
Effective Garage
Statement of owner’s equity
For the month ended September 30,200 x

Dawit G, capital September 1………………………………………………………………………………………………………………..Birr -

0-

Add: investments………………………………………………….Birr 100,000

Net income………………………………………………………….15,000 115,000

115,000

Less :
Drawings…………………………………………………………………………………………………………………………………………..3,000

Dawit G Capital, September 30………………………………………………………………………………………Birr 112,000

According the IFRS this statement is known as statement of changes in equity can be
explained as a statement that can changes in equity for corporation features be created for
partnerships . sole proprietorships or corporations . the key purpose of this statement is to
summarize the activity in take equity accounts for a certain period , sole proprietorships and
partnerships flow a similar format for their statements of changes in equity , on the contrary
, the statements of changes in equity for corporation features a slightly different format.
Balance sheet / statement of financial position
The balance sheet or the statement of financial position according to IFRS , lists the
company’s assets , liabilities and owner’s equity as of a specific date –usually at the end of
month or year .
Shown below is the balance sheet for effective Garage as of September 30,200x the
balance sheet heading contains the name of the company , the type of statement ,and the
specific date on which assets ; liabilities and owner’s equity are identified and measured .the
total asset must equal the total liabilities and owner’s equity , there are two commonly used
formats of the balance sheet:
A. The account format
Which lists asset on the left side and equities (I. e liabilities and owner’s equity) on the right
side ? it resembles a basic accounting format called an ‘account’ to be introduced in unit 2.

asset Liability
Owner’s equity

B. The report format

Lists assets, liabilities and owner’s equity vertically

Asset
Liability
Owner’s equity

You can choose either of two format for your balance sheet preparation .
The following is a balance sheet prepared for effective Garage based on the sample
transactions illustrated in the chapter
Asset Liability
Cash……………………………….. Birr 90,500 Accounts payable…………………..Birr 1,000
Supplies………………………………….2,500
Land………………………………………20,000 Owner’s equity
Ato Dawit Gem, capital Birr 12,000
Total asset…………………..113,000 Total liability and owner’s
equity………………………………113,000

The double line is drawn only when the total assets on the left side are equal to the total
liabilities and owner’s equity , in the effective Garage illustration , only one liability-account
payable is reported on the balance sheet , in most cases , there will be more than one
liability , when two or more liabilities are involved , a customer way of listing is as follows:
Liabilities
Notes payable 10,000
Accounts payable 1,000
Salaries payable 2,000
_______________
Total liabilities 13,000
Each statement provides management , ower’s , and other interested parties which
relevant financial data , this financial statements are interrelated (1) Net income of Birr
15,000 shown on the income statement is added to the beginning balance of owner’s capital
in the owner’s equity statement . (2) owner’s capital of Birr 112,000 at the end of reporting
period shows in owner’s equity statement is reported on the balance sheet as Dawet G/M
capital balance , be sure to carefully examine the format and content of each statement .
SUMMARY
Explain the meaning of accounting , accounting is the process of
identifying ,measuring ,recording and communicating the economic events of an
organization ( business or non- business) to interested users of information , accounting
helps us in the allocation of scarce resources in an efficient and effective manner .
Identify the users and uses of accounting .
(a) management uses accounting information in planning controlling and evaluating
business operations.
(b) Investors(owners) judge the wisdom of buying ,holding or selling their financial
interests on the basis of accounting data ,I.e to see how their investments is doing
 (c) Creditors evaluate the risks of granting credit or lending money , other groups of
users include taxing authorities ,regulatory agencies ,customers ,Labor unions and
income panniers ,these users are grouped in to two ;1-internal users and 2-external
users
Services:-refers to the provision of mental or physical assistance e.g.teaching
Trade :-refers to purpose of buying and selling goods e.g. selling clothes

Business Enviroment
Business environment refers to the condition under which a business operates in society
. for the business to survive and grow , it has to be vigilant and watch for changes into
business

Types of business environment and how they influence a business

Business environment are subdivided into two major characteristics :
a) Internal environment
b) External environment
The internal environment comprises the condition that refers the business from with
in ,these include the following
 Objectives: the objective of a business provide a plan of action on how to provide
customers with the best goods and services at the best prices
 Management policies and styles: these determine the activities of a business as
well as how workers relate with their managers
 Employees, skills, knowledge and values;-these affects how successfully workers
carry out of their duties
 Financial :resources money is needed to pay for production , labor and expansion
 Equipment :- proper equipment helps employees to perform their duties more
effectively and efficiently
 Culture: the business culture determines which values are upheld by
workers ,positive values such as team work have a positive impact while negative
values such as nepotism have a negative impact.
 Research and development :- these generate new ideas or improve old
ones ,helping to out do competitors and boost customer satisfaction .
The external environment refers to the conditions that affect a business from outside ,these
conditions include the following ;
 Competitors : a business uses information about competitors to gain an advantage
over them , if a business is disadvantaged relative the competition , it loses
profitability
 Suppliers: the cost of material bought from the suppliers determines the price of a
product .
 Customers: a business must identify the customer’s needs and then adjust its
operation to meet those needs , if a business doesn’t meets its target market’s needs
,it losses customers.
 GAAP(generally accepted accounting principle)
 FASB(financial accounting standard board)
 IFRS(international financial reporting standard)
 IASB(international accounting standard board)
 ACCOUNTING (is a process of identifying measuring recording and communicating
economic events of organization to interested users of the information
 Accounting is a language of business because it plays a great role in decision making
process of business entities