Our accounting class has been started one month ago. However, we have a new foreign student, who no zero accounting background, joins in our class. Since our lecturer has finished chapter one to three, he cannot catch up with the syllabus. Therefore, he seeks our assistance, to guide him. So, we have decided to provide him the knowledge that we have leant so far.
1.1 Purpose of Accounting
Accounting is the process of recording, classifying, summarizing, reporting business transactions and interpreting their effects on the affairs of a company. It serves as the language of the business, to communicate the affairs with the users. Doing proper accounts is very important for a few reasons. First of all, accounts provide financial information of a business entity in a systematic manner. It certifies the accuracy of records by preparing financial statements like trading accounts and balance sheet. The management use the information provided to measure the financial performance of the business over the accounting period. The information is also very vital for them to make economic decisions regarding the entity operation.
In addition, accounts keep track of cash inflows and outflow. Transaction recorders who are bookkeepers and decision makers like stockholders and managers have to make budgets, projections, financial reports, highlight areas of profitability or loss according to the accounts, to provide factual information about the financial position of the entity. This is done to maximize profit.
Furthermore, accounts can provide information to governments. Tax authorities need the accounts to review or evaluate tax returns. Some government departments use the accounts information to check that whether the business entity is following government rules and regulation or not.
1.2 Users of Accounting Information
There are many users of accounting information. Users of accounting information fall into two categories which are external users and internal users.
The internal users are including the managerial accounting from inside of the business. Owners use accounting information to make buy, sell or keep decisions related to shares. Owners use this accounting information to indentifies the firm is gaining or losing. They also make the decision on whether to increase or decrease their existing ownership in the firm. Managers also are the one of the users of accounting information. Managers of the business will want to know how things are going. They need financial information in order to plan for the future; they then need more up-to-date information in order to check whether actual performance is on target.
External users are including the financial accounting from outside of the business. Employees or labour union need to know if the company has the ability to pay wages and fringe benefits. Employees require information about the stability and continuing profitability of the business. They only interested in a company’s financial statements because they want the safety of their daily bread, and they also want to increase their wages and salaries. Many government agencies and departments are interested in accounting information so as to evaluate or review tax returns. They need to ensure that the business enterprises are following the government rules and regulations. Besides that, creditors require information that can help them understand and assess the short-term liquidity of a business. They need to convince that the business is liquid enough to meet with the obligation upon maturity. They are looking for information on cash flow, management of working capital and payment policy. Finally, Investors are concerned about risk and return in relation to their investments. They require information to decide whether they should continue to invest in a business. They also need to be able to assess whether a business will be able to pay dividend.
1.3 Books Used in Accounting
There are two types of accounting books that are ledger and journal. Ledger is the main accounting record of a business which uses double-entry bookkeeping and it is also known as the two column T-accounts. Ledger shows the collection of the firm’s account and all the accounting transactions are posted in the ledger using debit entry which is on the left hand side and credit entry which is on the right hand side for each transaction. It usually includes accounts for liabilities, expenses, revenue, fixed assets and current assets. Ledger allows people to check the balance and activities of each account clearly.
The sample of T-account/ledger is as shown below:
Title of account
Journal is a formal and chronological record of transactions showing the date of the transaction, title of the account debited, title of account credited, amount of the debit and credit, and description of the transaction. Journal is where the information from the source document first enters the accounting system, therefore it is known as the book of original entry.
A journal takes the following format:
Format of Journal