Raya University

Business and Economics

Accounting and Finance Program

Course Title: Financial Accounting I

By: Mr. Fantay Alemayehu
 Chapter one
Development of accounting principles & professional practice

The environment of Accounting

• 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 responsibilities placed on accounting are greater today than
ever before.
• If accountants are to meet this challenge, they must have a
logical and consistent body of accounting theory to guide
them.
 Cont’d
• This theoretical structure must be realistic in terms of the
economic environment and must be designated to meet the
need 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.
• The basic assumptions that underlie current accounting
practice have evolved over many years in response to the need
of various users of accounting information.
• Remembrance: accounting is the process of identifying,
measuring, recording, analyzing, and communicating an
organization’s economic activities to users in the form of
financial statements for making their decisions.
• We may think of accounting as a special “language” used to
communicate financial information about a business to these
who wish to use the information to make decisions.
• The essential characteristics of accounting are (1) the
identification, measurement, and communication of financial
information about (2) economic entities to (3) interested
parties.
 Cont’d
• Financial statements are the principal means through which a
company communicates its financial information to those
outside it.
• These statements provide a company’s history quantified in
money terms.
• The financial statements most frequently provided are:
 the balance sheet,
 the income statement,
 the statement of cash flows, and
 the statement of owners’ or stockholders’ equity.
• Note disclosures are an integral part of each financial
statement.
 Financial accounting

• It is concerned with the way businesses communicate financial

information to the public: the various categories of people who
either invest in, or lend money to, and do business with a
company.
• These people rely on a company’s financial statements and
other information reports to make investment and other
financial decisions about the company.
• Financial accounting is charged with the primary
responsibility of external reporting.
 What is a business?

• Businesses of whatever size or nature exist to make a profit. A

business is an integrated set of activities and assets that is
capable of being conducted and managed for the purpose of
providing a return in the form of dividends, lower costs or
other economic benefits directly to investors or other owners,
members or participants.
• Businesses vary from very small businesses to very large ones.
However, all of them want to earn profits.
 Business Organizations
• An organization is a group of individuals who come together
to pursue a common set of goals and objectives.
• There are typically two types of organizations: business and
non-business.
• A business organization sells products or services for profit. A
nonbusiness organization, such as a charity or hospital, exists
to meet various societal needs and does not have profit as a
goal.
• All organizations record, report, and, most importantly, use
accounting information for making decisions.
• There are three common forms of business organizations—a
proprietorship, a partnership, and a corporation.
 Cont’d

• A proprietorship is a business owned by one person. It is not a

separate legal entity, which means that the business and the
owner are considered to be the same.
• A partnership is a business owned by two or more individuals.
Like the proprietorship, it is not a separate legal entity.
• A corporation is a business owned by one or more owners. The
owners are known as shareholders.
• Unlike the proprietorship and partnership, a corporation is a
separate legal entity. This means, for example, that from an
income tax perspective, a corporation files its own tax return.
 Cont’d
• The owners or shareholders of a corporation are not
responsible for the corporation’s debts so have limited liability
meaning that the most they can lose is the amount they
invested in the corporation.
• They are not responsible for all the debts of an organization.
• For accounting purposes, all three entities are treated as
separate from their owners. This is called the business entity
concept.
• Note that it is not only businesses that need to prepare
financial statements.
 Financial accounting vs Management accounting

• An accounting information system provides data to help

decision makers both outside and inside the business. Decision
makers outside the business are affected in some way by the
performance of the business.
• Decision makers inside the business are responsible for the
performance of the business. For this reason, accounting is
divided into two categories: financial accounting for those
outside and managerial accounting for those inside.
• Financial accounting information appears in financial
statements that are intended primarily for external use
(although management also uses them for certain internal
decisions).
 Cont’d
• Consequently, financial accounting information relates to the
company as a whole, while managerial accounting focuses on
the parts or segments of the company.
• Managerial accounting information is for internal use and
provides special information for the managers of a company.
• Thus, management accounting, sometimes known as cost
accounting, is a management information system which
analyses data to provide information as a basis for managerial
action.
 The reporting entity
• A reporting entity is an entity whose general purpose
financial statements are relied upon by other parties, or
users of the accounts.
The need for financial statements
• The purpose of financial statements is to provide useful
information about the financial position, performance and
changes in financial position of an entity to a wide range
of users.
• Users need this information for two reasons:
 to make economic decisions; and
 to assess the stewardship of management.
 Users of financial statements and accounting information
• A business should produce information about its activities
because there are various groups of people who want or need
to know that information.
• The following people are likely to be interested in financial
information about a company with listed shares.
• (a) Managers of the company appointed by the company's
owners to supervise the day-to-day activities of the company.
• (b) Shareholders of the company, i.e. the company's owners,
want to assess how well the management is performing.
• (c) Trade contacts include suppliers who provide goods to the
company on credit and customers who purchase the goods or
services provided by the company.
• (d) Providers of finance to the company might include a bank
which allows the company to operate an overdraft, or provides
longer-term finance by granting a loan.
 Cont’d
•(e) The taxation authorities want to know about business profits in
order to assess the tax payable by the company.
•f) Employees of the company should have a right to information about
the company's financial situation, because their future careers and the
size of their wages and salaries depend on it.
•(g) Financial analysts and advisers need information for their clients or
audience.
•(h) Government and their agencies are interested in the allocation of
resources and therefore in the activities of business entities.
•(i) The public. Companies affect members of the public in a variety of
ways.
•Accounting information is summarized in financial statements to
satisfy the information needs of these different groups.
•These information needs will differ between each user group and not
all will be equally satisfied.