PART- ONE: BASIC CONCEPTS AND FINANCIAL STATEMENTS

UNIT 1: THE ENVIRONMENT OF ACCOUNTING

Contents
1.0 Aims and Objectives
1.1. Introduction
1.2. Environmental Factors that Influence Accounting
1.3. Nature and Environment of Financial Accounting
1.4. Users of Accounting Information
1.5. Organizations and Laws Affecting Financial Accounting
1.6. Summary
1.7. Answers to Check Your Progress
1.8. Model Examination Questions
1.9. Glossary

1.0. AIMS AND OBJECTIVES

This unit aims at discussing the nature and environment of accounting in general and financial
accounting in particular.

After you have studied this unit, you will be able to:

 know the environment factors that influence accounting

 understand the nature and environment of financial accounting
 know the users of accounting information
 explain organizations and laws affecting financial accounting.

1.1. INTRODUCTION

Fair presentation of financial affairs is the essence of accounting theory and practice. With
the increasing size and complexity of business enterprises and the increasing economic role of
government, the responsibility placed on accountants is greater today than ever before. If
accountants are to meet this challenge, they must have a logical and consistent body of

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accounting theory to guide them. This theoretical structure must be realistic in terms of the
economic environment and must be designed to meet the needs of users of financial
statements.

Financial statements and reports prepared by accountants are vital to the successful working
of society. Economists, investors, business executives, labor leaders, bankers, and
government officials all rely on these financial statements and reports as fair and meaningful
summaries of day-to-day business transactions In addition, these groups are making increased
use of accounting as a base for forecasting future economic trends.

1.2. ENVIRONMENTAL FACTORS THAT INFLUENCE ACCOUNTING

Accounting, like other social science disciplines and human activities, is largely a product of
its environment. The environment of accounting consists of social-economic – political- legal
conditions, constraints, and influences which have varied from time to time. Accounting
theory and practices have evolved to meet changing demands and influences. Modern
accounting is the product of many influences and conditions, three of which deserve special
consideration.

First, accounting recognizes that people live in a world of scarce resources. Because
resources exist in limited supply, people try to concern them, to use them effectively and
efficiently, and to identify and encourage those who can make effective and efficient use of
them. Accounting plays a useful role in obtaining a higher standard of living because it helps
to identify efficient & inefficient users of resources.

Second, accounting recognizes and accepts society’s current and ethical concepts of property
and other rights when determining equity among the varying interests in an enterprise or
entity. Accounting looks to its environment for direction with regard to what property rights
society protects, what society recognizes as value, and what society acknowledges as
equitable & fair.

Third, accounting recognizes that in highly developed, complex economic systems, some
(owners and investors) entrusts the custodianship of and control over property to others

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(managers). One of the results of the corporate form of organization has been the tendency in
large enterprises to divorce ownership and management

Thus, the function of measuring and reporting information to absentee investors (eg. Share
holders) has been added to that of recording and presenting financial data for owner –
manager use. This development greatly increased the need for accounting standards (rules of
practice governing the contents, measurements, and disclosures in financial statements).

Check your progress-1

1. Modern accounting is the product of many influences and conditions. List three
conditions that deserve special consideration.
_____________________________________________________________________
________________________________.

1.3. NATURE AND ENVIRONMENT OF FINANCIAL ACCOUNTING

For purposes of study and practice, the discipline of accounting is commonly divided into the
following areas or subsets: financial accounting, managerial (cost) accounting, tax accounting,
and not- for- profit (public sector) accounting. This book concentrates on financial
accounting. Financial accounting has been characterized as “that branch of accounting
concerned with the classification, recording, analysis, and interpretation of the overall
financial position and operating results of an organization. Financial accounting encompasses
the process and decisions that culminate in the preparation of financial statements relative to
the enterprise as a whole for use by parties both internal and external to the enterprise. These
statements provide a continual history qualified in money terms of economic resources and
obligations of a business enterprise and of economic activities that change these resources and
obligations. The following four environmental factors, although not as basic as the three
aspects described in environmental factors that influence accounting, shape financial
accounting to a significant extent:
 The many users and uses that accounting serves
 The nature of economic activity
 The economic activity in individual business enterprises
 The means of measuring economic activity.

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Check your progress-2
1. What is financial accounting?
_____________________________________________________________________
___________________________________.

1.4 USERS OF ACCOUNTING INFORMATION

The basic assumptions that underlie current accounting practice have evolved over many
years in response to the needs of various users of accounting information. The users of
accounting information may be divided into two broad groups: internal users and external
users.

Internal users include all the management personnel of a business enterprise who use
accounting information either for planning and controlling current operations or for
formulating long-range plans and making major business decisions. The term managerial
accounting relates to internal measurements and reporting; it includes the development of
detailed current information helpful to all levels of management in decision making designed
to achieve the goals of the enterprise.

External users of accounting information include stock-holders, bondholders, potential

investors, bankers and other creditors, financial analysts, economists, labor unions, and
numerous government agencies. The field of financial accounting is directly related to
external reporting because it provides investors and other outsiders with the financial
information they need for decision making.

Check your progress-3

Explain the distinction between financial and management accounting.

1.5. ORGANIZATIONS AND LAWS AFFECTING FINANCIAL ACCOUNTING

Certain professional organizations, governmental agencies, and legislature acts have been
extremely influential in shaping the development of the existing body of financial accounting
theory. Among the most important of these have been the International Accounting standards,
the financial Accounting standards in U.K., the American Institute of certified public

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Accountants, the Association of chartered certified Accountants (ACCA) in U.K., the
American Accounting Association etc.
Awareness of the roles of these in situational forces is helpful in gaining an understanding of
current accounting principles and practices. Efforts to improve existing principles of
accounting will have a better chance of success if they are made with full recognition of the
needs of the various groups that use accounting information.

In this course, we will depend on the laws or principles established by financial Accounting
standards Board (FASB). So, let us see what FASB is.

Financial Accounting standards Board (FASB)

The financial Accounting standard Board was established in 1972 to develop financial
accounting standards for business enterprises and nonprofit organizations. This independent
body consisted of seven full- time members and a large supporting staff.

Lending support and counsel to the FASB are the Financial Accounting Foundation, which
appoints members of the FASB and raises funds for its operations, the Financial Accounting
Standards Adivisory Council, a screening committee on Emerging problems, and numerous
taskforces consisting of financial executives, accounting educators, lawyers, and
CPAs(Certified public Accountants)

The FASB is authorized to issue statements of financial Accounting standards, as well as

Interpretations and Technical Bulletins, to guide individuals and organizations in preparing
and auditing financial statements. Before a formal statement is drafted, the FASB frequently
issues a Discussion Memorandum that identifies and analyses the issues to be considered.
Public learning then are held on the issues identified in the Discussion Memorandums. Next,
an Exposure Draft of the proposed statement is circulated. These procedures are designed to
encourage the widest participation possible by all interested parties before a new financial
accounting standard is issued. As of the beginning of 1985 the FASB had issued 82
statements. Those statements dealing with the subject matter of Intermediate Accounting
have been incorporated in this book to the maximum extent possible.

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1.6 SUMMARY

The purpose of this chapter has been to provide a perspective, which can serve as a starting
point for understanding financial accounting and as a base for doing it. Basically, we have
described the nature of financial accounting, the environmental factors, which have influenced
its development, the useful role it can play in influencing the environment, the many users of
accounting information, and the organizations, which influence financial accounting. From
this description, it is a means to an end rather than an end in itself. Because the environment
with in which accounting exists is constantly changing, one can expect accounting to continue
to evolve in response to this changes. Indeed continuous evolution has been a constant theme
throughout the history of accounting.

1.7 ANSWERS TO CHECK YOUR PROGRESS

1. a) Accounting recognizes that people live in a world of scarce resources.

b) Accounting recognizes and accepts society’s current and ethical concepts of
property and other rights when determining equity among the varying interests in
an enterprise or entity.
c) Accounting recognizes that in highly developed, complex economic systems, some
entrust the custodianship of and control over property to others.
2. Financial accounting is a branch of accounting concerned with the classification,
recording, analysis and interpretation of the overall financial position and operating
results of an organization.
3. Financial accounting is directly related to external reporting it encompasses the process
and decisions that culminate in the preparation of financial statement relative to the
enterprise for use by parties management accounting relates to internal measurements
and reporting. It focuses on the planning and controlling functions in an enterprise.

1.8. MODEL EXAMINATION QUESTIONS.

I: True/False questions
_________ 1. The environment of accounting is unaffected by social – economic- Legal

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 conditions, restraints, and influences that vary from time to time.
_________2. Financial accounting is the process that culminates in the preparation of
financial reports that are relative to the enterprise as a whole and parties both
internal and external to the enterprise use that.
_________ 3. The purpose of accounting is to provide qualitative financial information about
an economic entity to person interested in activities of that entity.
_________ 4. Accounting is considered as a means to an end.
_________ 5. Accounting is an unchanging discipline with its environment and other
influences.
_________ 6. Financial accounting – focuses primarily on internal users of financial
statements.
_________ 7. Management accounting is directly concerned with stock holders and creditors.
_________ 8. External decision makers (users) Lack direct access to the information
generated by the internal operations of a company.
_________ 9. A major role of the Accounting Standards Executive committee (AcSEC) is to
inform the FASB of financial reporting problems that are developing in
practice.
_________10. One of the objectives of financial reporting is to provide information that is
useful in assessing cash flow prospects of the entity being reported on

II. Short Answer Questions.

1. Describe the procedures followed by the Financial Accounting standards board in the
development of a new financial accounting Standard.
2. Governmental agencies are one of the external users of accounting information. For
what purposes do governmental agencies use accounting information?
3. Why does financial accounting emphasize communication?

1.9 . GLOSSARY

1. External Users –are those who lack direct access to the information generated by the
internal operations of a company.

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2. Financial Accounting – is concerned with the way businesses communicate financial
information to the public the various categories of people who invest in, lend money
to, or do business with a company.
3. FASB – is an independently funded private organization operating under extensive
due process procedures, broad participation, and authority delegated through congress
and SEC to formulate accounting principles.
4. Internal users – are those responsible for planning the future of the business,
implementing those plans, controlling daily operations, and reporting information to
other operating officers.
5. Management Accounting – a branch of accounting that uses both historical and
estimated data in providing information which management uses in conducting daily
operations and in planning future operations.