Accounting (Basics) - Lecture 1
SUBSTANCE AND FUNCTIONS OF ACCOUNTING, GENERAL ACCOUNTING PRINCIPLES. BALANCE SHEET, ITS FUNCITON,
SYSTEM AND UTILIZATION.

Content
nSubstance and functions of accounting
nGeneral accounting principles
nBalance sheet
nFunction, system and utilization of balance sheet
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What is accounting
n
nSystem of recording, categorizing, summarizing and communicating financial information about an
organization
nOften called the „language of business“
nHelps decision-makers make good economic decisions
nCommunicates financial consequences of business decision
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Accounting as an information system
nAccounting can be viewed as an information system that provides essential information about the
financial activities of an entity to various individuals or groups for their use in making informed
judgments and decisions. nAccounting information is composed principally of financial data about
business transactions, expressed in terms of money. nThe recording of transaction data may take
various forms, such as pen or pencil markings made by hand, printing by mechanical and electronic
devices, or magnetic impressions on tape or disks.
n
n
n
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Accounting as an information system
nSpecial accounting softwares for accounting evidence have been used by most enterprises in all
developed countries. Markings made by hand have become a history. nThe mere records of transactions
are of little use in making informed judgments and decisions. nThe recorded data must be sorted and
summarized and then presented in significant reports. nThe usefulness of reports is often improved
by various kinds of percentage and trend analyses.
n
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Users of accounting information
nAccounting provides the techniques for gathering economic data and the language for communicating
these data to different individuals and institutions. nInvestors in a business enterprise need
information about its financial status and its future prospects. nBankers and suppliers appraise
the financial soundness of a business organization and assess the risks involved before making
loans or granting credit. nGovernment agencies are concerned with the financial activities of
business organizations for purposes of taxation and regulation.
n
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Users of accounting information
nEmployees and their union representatives are also vitally interested in the stability and the
profitability of the organization that hires them. nManagement needs reliable information for
effective managing. nThe individuals who depend upon and make the most use of accounting are those
charged with the responsibility for directing the operations of enterprises.
nThey are often referred to collectively as "management."
nManagement relies upon many types of accounting data in conducting day-to-day operations, in
evaluating current operations, and in planning future operations.
n
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Development of financial accounting concepts and principles
nThe historical development of the practice of accounting has been closely related to the economic
development of the country. In the earlier stages, a business enterprise was very often managed by
its owner, and the accounting records and reports were used mainly by the owner-manager in
conducting the business. nBankers and other lenders often relied on their personal relationship
with the owner rather than on financial statements as the basis for making loans for business
purposes. If a large amount was owed to a bank or supplier, the creditor often participated in
management decisions.
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Development of financial accounting concepts and principles
nAs business organizations grew in size and complexity, "management" and "outsiders" became more
clearly differentiated.
nOutsiders demanded accurate financial information.
nIn addition, as the size and complexity of the business unit increased, the accounting problems
involved in the issuance of financial statements became more and more complex. nWith these
developments came an awareness of the need for a framework of concepts and generally accepted
accounting principles to serve as guidelines for the preparation of the basic financial statements.
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Development of financial accounting concepts and principles
nAccounting principles have been developed by individuals to help make accounting data more useful
in an ever-changing society. nThey represent guides for the achievement of the desired results,
based on reason, observation, and experimentation. nThe selection of the best method from among
many alternatives has come about gradually, and in some areas a clear consensus is still lacking.
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Development of financial accounting concepts and principles
nThese principles are continually reexamined and revised to keep pace with the increasing
complexity of business operations. nGeneral acceptance among the members of the accounting
profession is the criterion for determining an accounting principle.
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Practical keeping of accounting evidence
nThe practical keeping of accounting evidence can be divided into 2 basic groups:
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n1. Hand-making evidence
n2. Computerized accounting system
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nThe hand-making accounting evidence has started to be a history. nThis system of evidence of
accounting files is able only in case of smaller accounting units or businessmen.
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Practical keeping of accounting evidence
nOnly the computerized accounting system is the leading form of keeping of accounting in bigger
companies. nSince the electronic computer was first used to process business data in the middle of
the twentieth century, it has played an ever increasing role in the design of accounting systems
and the processing of accounting data. nIt has generally enabled interested users of accounting
information to receive relevant economic data on a more timely basis at a lower cost.
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Practical keeping of accounting evidence
nThe integration of the electronic computer into accounting systems has created both opportunities
and challenges for accountants. nThe computer provides opportunities for accountants to analyze
efficiently a greater quantity of economic data for reporting to users. nAs the use of computers in
business continues to accelerate, there will be an increasing demand for accountants to aid the
analysis, design, and implementation of these systems.
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Practical keeping of accounting evidence
nThis responsibility will create ever greater challenges for accountants to obtain a complete
understanding of business operations and the principles of designing systems that will gather all
accurate, relevant data on a timely basis. nA lot of software companies develop special accounting
software used for keeping of accounting evidence. nThe latest sophistic versions of accounting
software (but of course the most expensive versions) allow to the business entities not only to
keep the accurate accounting evidence but also to use the accounting data effectively for better
managing of the business.
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Financial statements
nA set of financial statements include:
qThe statement of financial position (sometimes named as The balance sheet)
qThe statement of profit or loss and other comprehensive income (sometimes named as The income
statement)
qThe statement of changes in equity
qThe statement of cash flows
qThe notes
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The statement of financial position – balance sheet
nThis summarises the assets, liabilities and equity balances of the business at the end of the
reporting period.
nBalance sheet
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The statement of profit or loss – income statement
nThis statement summarises the revenues earned and expenses incurred by the business throughout the
whole of the reporting period
nIncome statement
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The statement of changes in equity
nThis statement summarises the movement in equity balances (share capital, share premium,
revaluation reserve, retained earnings) from the beginning of the reporting period to the end
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The statement of cash flows
nIt summarises the cash physically paid and received throughout the reporting period
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The notes
nThese comprise the accounting policies disclosures and any other disclosures required to enable to
the shareholders to make informed decisions about the business
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Qualitative characteristics
nThese are the attributes that make information provided in financial statements useful to others
nWe split the qulitative characteristics into two groups
n1) Fundamental qualitative characteristics
n2) Enhancing qualitative characteristics
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Fundamental qualitative characteristics
nRelevance
qInformation is relevant if it has the ability to influence the economic decisions of users
qand is provided in time to influence those decisions
nFaithful representation
qIf information is to represent faithfully the transactions and other events that it purports to
represent, they must be accounted for and presented in accordance with their substance and economic
reality and not merely their legal form
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Enhancing qualitative characteristics
nComparability
nVerifiability
nTimeliness
nUnderstandability
n
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Enhancing qualitative characteristics
nComparability
qUsers must be able to:
qcompare the financial statements of an entity over time to identify trends in its financial
position and performance
qcompare the financial statements of different entities to evaluate their relative financial
performance and financial position
q
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Enhancing qualitative characteristics
nVerifiability
qDirect – verifying an amount or other representation through direct observation (i.e. counting
cash)
qIndirect – checking the inputs to a model, formula or other technique and recalculation the
outputs using the same methodology
q
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Enhancing qualitative characteristics
nTimeliness
qMeans having information available to decision makers in time to be capable of influencing their
decisions
qGenerally the older the information is, the less useful it becomes
q
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Enhancing qualitative characteristics
nUnderstandability
qDepends on the way in which information is presented and the capabilities of users
qIt is assumed that users have a reasonable knowledge of business and economic activities and are
willing to study the information provided with reasonable dilligence
qFor information to be understandable users need to be able to perceive its significance
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Other important accounting principles
nThere are numbers of other accounting principles that underpin the preparation of financial
statements. The most significant ones include
qThe business entity concept
qThe accruals basis of accounting
qThe going concern assumption
qSubstance over form
qConsistency
q
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Other important accounting principles
nThe business entity concept
qThis principle means that the financial accounting information presented in the financial
statements relates only to the activities of the business and not to those of the owner
qFrom an accounting perspective the business is treated as being separate from its owners
q
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Other important accounting principles
nThe accruals basis of accounting
qThe transactions are recorded when revenues are earned and when expenses are incurred
qThis pays no regard to the timing of the cash payment or receipt
qFor example if a business enters into a contractual arrangement to sell goods to another entity,
the sale is recorded when the contractual duty has been satisfied – that is likely when the goods
have been upplied and accepted by the customer. The payment may not be received for another month
but in accounting terms the sale has taken place and should be recognised in the financial
statements.
q
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Other important accounting principles
nThe going concern assumption
qFinancial statements are prepared on the basis that the entity will continue to trade for the
foreseeable future
qi. e. it has neither the need nor the intention to liquidate its operations
q
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Other important accounting principles
nSubstance over form
qIf the information is to be presented faithfully the economic reality must be accounted for and
not just the legal form
qExample: accounting treatment of redeemable preference shares – on legal form these are shares,
there is an obligation to repay the preference share holders and so they are accounted for as debt
q
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Other important accounting principles
nConsistency
qUsers of the financial statements need to be able to compare the performance of a company over a
number of years.
qTherefore it is important that the presentation and classification of items in the financial
statements is retained from one period to the next, unless there is a change in circumstances or a
requirement of a new IFRS
q
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The elements of the financial statements
nAssets
nLiabilities
nEquity
nRevenues
nExpenses
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The elements of the financial statements
nAssets
qAn asset is a property controlled by the entity as a result of past events from which future
economic benefits are expected to flow to the entity
qFor example a building that is owned and controlled by a business and that is being used to house
operations and generate revenues would be classed as an asset
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The elements of the financial statements
nLiabilities
qA liability is an obligation to transfer economic benefit as a result of past transactions or
events
qFor example an unpaid tax obligation is a liability
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The elements of the financial statements
nEquity
qThis is the residual interest in a business and represents what is left when the business is wound
up, all the assets sold and all the outstanding liabilitites paid
qIt is effectively what is paid back to the owners (shareholders) when the business ceases to trade
q
qAssets = Liabilities + (Owner's) Equity
q
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The elements of the financial statements
nRevenue
qThis is the recognition of the inflow of economic benefit to the entity in the reporting period
qThis can be achieved, for example, by earning sales revenue or through the increase in value of an
asset
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The elements of the financial statements
nExpenses
qThis is the recognition of the outflow of economic benefit from an entity in the reporting period
qThis can be achieved, for example, by purchasing goods or services off another entity or through
the reduction in value of asset
q
q
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The balance sheet
nThe balance sheet is the most important financial statement compiled in the system of double –
entry accounting. nIt provides information about the structure of assets and equities (liabilities
+ equity).
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The balance sheet
1. Fixed assets
-intangible assets
-tangible assets
-long-term financial assets
2. Current assets
-inventories
-long – term receivables
-short – term receivables
-short – term financial assets
1. Owner’s equity
-common stocks
-capital funds
-funds created by net profit
-economic results
2. Liabilities
-Reserves (provisions)
-long – term debts (liabilities)
-short - term debts (liabilities)
-bank credits (loans)
Σ Assets
Σ Equities
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Assets
       Equities

The balance sheet
nDefinition: Σ Assets or Σ Equities is called The balance sheet amount.
nΣ Assets = Σ Equities
nVery important:
qThis equation must stay in balance after the charging of every transaction!
nRemember:
qThere is no economic transaction that could evoke an imbalance in this equation!!!
n
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Components of the balance sheet
nThe balance sheet components can be divided into two basic sides – into assets recorded on assets
side of the balance sheet and on equities recorded on the equity side of the balance sheet. nThe
asset side of the balance sheet is divided into next two parts – the fixed assets and the current
assets. nThe equity part of the balance sheet is also divided into two basic parts – into the
owner’s equity and the liabilities.
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Components of the balance sheet
nAssets
qFixed assets
qCurrent assets
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nEquities
qOwner’s equity
qLiabilities
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