UNIT 1: ROLE OF ACCOUNTING INFORMATION AND

RECORDING AND SUMMARISING TRANSACTIONS

UNIT STRUCTURE

1.0 Overview
1.1 Learning Outcomes
1.2 Users of Accounting Information
1.3 Differences between Management Accounting and Financial Accounting
1.4 Bookkeeping
1.5 Definition of assets, liabilities, equity, income and expenses
1.6 Double Entry System
1.7 Summary
1.8 Activities

1.0 OVERVIEW
Accounting is defined as the process of collecting, analysing and communicating financial
information to users of accounting information so as to enable them in making informed
decisions about allocation of scarce resources. There would be no need to produce accounting
information if it is not able to improve decision making. There are different user groups or
stakeholders that are interested in an organisation or are affected by the existence of a
particular organisation. Different users groups have different information needs.

1.1 LEARNING OUTCOMES

By the end of this unit, you should be able to do the following:
1. Identify the users of accounting information.
2. Distinguish between financial accounting and management accounting.
3. Define bookkeeping.
4. Define assets, liabilities, equity, income and expenses.
5. Explain the accounting equation.
6. Explain the rules of the double entry system.
1.2 USERS OF ACCOUNTING INFORMATION

The aim of accounting is to provide useful information to its users and the major users of
accounting information are as follows:
 Management
 Shareholders/Owners
 Potential Investors
 Lenders
 Employees
 Government
 Public

Management needs information for decision making and control activities such as
information on costs, selling prices, competitive position of the firm, profitability of its
products and services and profitability of the firm as a whole. Shareholders need information
to assess the performance of the firm, the value of their investment and the dividend that can
be derived from their shareholding. Potential investors require information to assess the
performance of firms and to decide in which firm it is beneficial for them to invest. Creditors
and lenders require information on the ability of the firm to meet its financial obligation. In
addition, employees need information on the ability of the firm to pay their salaries and to
ensure job security. Government requires accounting information for tax purposes and also to
determine policies to manage the economy of the country. Finally, the public requires
information to determine the impact of the economic activities of a firm on the society and
the environment.

An assessment of the different users of accounting information indicates that the users can be
separated into two major categories namely:
 Internal users
 External users

The internal users of accounting information are referred to as parties that are within the firm
such as the management whereas external users are external parties such as shareholders,
potential investors, lenders, employees, government and the public. It is therefore possible to
differentiate between the branches of accounting namely management accounting and
financial accounting. Management accounting focuses on providing information to people
internal to the firm to enable them in making better decision.

On the other hand, financial accounting focuses on providing information to external users
that cannot have specific information about the firm as and when these require. Consequently
management accounting may be referred to as internal reporting while financial accounting
may be referred as external reporting. The differences between these two branches of
accounting are explained in the following section.

1.3 DIFFERENCES BETWEEN MANAGEMENT ACCOUNTING AND

FINANCIAL ACCOUNTING

Management Accounting Financial Accounting

Internally Focused Externally Focused
No mandatory rules Must follow mandatory rules
Emphasis on the future Past oriented
No time interval Time interval

Management accounting measures the performance of different divisions and department

within the firm and is focused on providing information to internal users whereas financial
accounting provides information on the firm as a whole and is focused on providing
information to external users.

Financial Accounting information that is provided through the financial statements of

companies must be prepared according to the legal requirements and the relevant accounting
standards. On the other hand, management reports are not required to conform to the legal
requirement and relevant accounting standards that apply for financial reporting. In fact, the
aim of management accounting is to provide useful information to management to enable the
latter in the decision-making process.
Management accounting is future oriented whereas financial accounting is past oriented.
Management accounting provides information to management to make decision for the future
while financial accounting provides information to users about what has happened in the firm
over the past accounting periods.
Accounting information is provided to managers as and when required for decision-making
purpose. As such, management reports may be prepared on a daily, weekly, monthly or half-
yearly. However, financial statements must be prepared annually and some companies listed
on the stock exchange are required to prepare half- yearly reports and even quarterly reports.

1.4 DEFINITION OF BOOKKEEPING

Many transactions occur in a business and it is practically impossible to remember all of the
transactions. As such a business must record all transactions that take place so as to know
whether the business is profitable or not. Bookkeeping is one of the major functions of
financial accounting. Bookkeeping is the process of recording data relating to accounting
transactions in the accounting books throughout the course of a business. Accounting
transactions are classified into different activities such as assets, liabilities, equity, income
and expenses.

1.5 DEFINITION OF ASSETS, LIABILITIES, EQUITY, INCOME AND

EXPENSES
ASSETS

According to the IASB conceptual framework assets is defined as "a resource controlled by
the entity as a result of past events and from which future economic benefits are expected to
flow to the entity".

However for an item to be classified as an asset, it must fulfill the two recognition criteria
which are as follows:

 It is probable that the business will derive future economic benefits relating to the
item.
 The item can be reliably measured in monetary terms.

If one of the two recognition criteria is not meant, an item cannot be recognised as an
asset.
LIABILITIES

According to the IASB conceptual framework, a liability is defined as "a present obligation
of the entity arising from past events, the settlement of which is expected to result in an
outflow from the entity of resources embodying economic benefits".

However for an item to be classified as a liability, it must fulfill the two recognition criteria
which are as follows:

 It is probable that outflow of economic resources will arise relating to the item.
 The item can be reliably measured in monetary terms.

If one of the two recognition criteria is not meant, an item cannot be recognised as a
liability.

EQUITY

According to the IASB conceptual framework, equity is defined as “the residual interest in
the assets of the entity after deducting all its liabilities".

INCOME

IASB conceptual framework defines income as “increases in economic benefits during the
accounting period in the form of inflows or enhancements of assets or decreases of liabilities
that result in increases in equity, other than those relating to contributions from equity
participants"

EXPENSES

IASB conceptual framework defines expense as “decreases in economic benefits during the
accounting period in the form of outflows or depletions of assets or incurrences of liabilities
that result in decreases in equity, other than those relating to distributions to equity
participants"
Assets, liabilities and equity are balance sheet items. A balance sheet also called statement of
financial position demonstrates to users of accounting information what a business owns and
what it owes as at a specific point of time. In fact a balance sheet illustrates the accounting
equation which is as follows:

Resources in the business=Resources contributed by the owner

Assets=Equity

But if another party has provided some of the assets:

Assets= Equity + Liabilities

Equity = Assets – Liabilities

Income and expenses are income statement items. Income statement also called profit and
loss statement portrays all the income and expenses of a business over an accounting period.
It enables a business to calculate any profit or loss for an accounting period.

1.6 DOUBLE ENTRY SYSTEM

The double entry system was initiated during the year 1494 by Luca Pacioli, also known as
the father of accounting. According to this system, each transaction has two effects; one
which is the giving feature and the other one is the receiving feature. These effects need to be
illustrated in accounting books. The following illustrates an example of a double entry
account.

Title of the Account

The left hand side of the page is called the The right hand side of the page is called the
DEBIT side CREDIT side
The following table illustrates how recording in accounts affect balance sheet and income
statements items.

ACCOUNTS ENTRY IN ACCOUNT TO RECORD

ASSETS Debit Increase

Credit Decrease

LIABILITIES Debit Decrease

Credit Increase

EQUITY Debit Decrease

Credit Increase

INCOME Debit Decrease

Credit Increase

EXPENSES Debit Increase

Credit Decrease

Rules for making entries under double entry system

An owner starts business with cash

Dr: Cash/Bank A/C

Cr: Equity A/C

Purchase of non-current assets (ex:Equipment) with cash

Dr: Equipment A/C

Cr: Cash/Bank A/C

Purchase of non-current assets (ex:Equipment) on credit from Peter

Dr: Equipment A/C

Cr: Account Payable Peter

Purchase of goods for resale and paid cash

Dr: Purchases A/C

Cr: Cash/Bank A/C

Purchase of goods for resale on credit from Jack

Dr: Purchases A/C

Cr: Accounts Payable Jack

Sale of goods for cash

Dr: Cash/Bank A/C

Cr: Sales A/C

Sale of goods on credit to Kate

Dr: Accounts Receivable Kate

Cr: Sales A/C

Return part of goods bought on cash

Dr: Cash/Bank A/C

Cr: Return Outwards A/C

Return part of goods bought on credit from Jack

Dr: Accounts Payable Jack

Cr: Return Outwards A/C

Part of goods sold on cash were returned

Dr: Return Inwards A/C

Cr: Cash/Bank A/C

Part of goods sold on credit were returned by Kate

Dr: Return Inwards A/C

Cr: Accounts Receivable Kate

Paid office expenses by cash

Dr: Office Expenses A/C

Cr: Cash/Bank A/C

Paid electricity by cheque

Dr: Electricity Expenses A/C

Cr: Bank A/C

Received rent in cash

Dr: Cash/Bank A/C

Cr: Rent Received A/C

Drawings

Sometimes the owner of the business, especially in as sole-trader type of business the owner
may take money or goods for personal use from the business. This is called drawings.
Drawings reduce equity and they are never an expense of the business.
Owner takes cash out of business

Dr: Drawings A/C

Cr: Cash/Bank A/C

Owner takes goods out of business

Dr: Drawings A/C

Cr: Purchases A/C

Discounts

There are two types of discounts namely; Discount Allowed and Discount Received. A
business may provide discount to its customers so as to induce them paying quicker. This is
referred to as a Discount Allowed and is treated as an expense for the business. On the other
hand when a business receives discount so that it is encouraged to pay quicker, it is called a
Discount Received and is treated as an income in the books of the business.

Discount Allowed to Kate

Dr: Discount Allowed A/C

Cr: Accounts Receivable Kate

Discount Received from Jack

Dr: Accounts Payable Jack

Cr: Discount Received A/C

1.7 SUMMARY
 Accounting is defined as the process of collecting, analysing and communicating
financial information to users
 Management needs information for decision making and control purposes
 Shareholders need information to assess the performance of the firm, the value of
their investment and the dividend payable
 Government requires accounting information for tax purposes and also to determine
policies to manage the economy of the country
 Management accounting provides information to management to make decision for
the future
 Financial accounting provides information to users about what has happened in the
firm over the past accounting periods.
 Bookkeeping is one of the major functions of financial accounting
  An asset is a resource controlled by the entity as a result of past events and from
which future economic benefits are expected to flow to the entity.

 a liability is a present obligation of the entity arising from past events, the settlement
of which is expected to result in an outflow from the entity of resources embodying
economic benefits

1.8 ACTIVITIES
1. Identify, with relevant justifications, the major users of accounting information for
companies in the major industries of Mauritius
2. Explain fully the differences between management accounting and financial
accounting.