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Accounting mainly involves analyzing, interpretation and reporting of business transaction records. Accounting provides information for decision making to the management. The purpose of accounting is to maintain proper control of finances of an organization. In other words, accounting is an information system whose purpose is to provide essential information about business financial activities. It is primarily involves design of record keeping system, summarized reports based on the recorded data and eventually interpretation of the reports. (Duane and Charles 1991; Martin & Fernando 2002).
Four basic financial statements are:
This records assets and liabilities as well as owner’s equity of a business entity. Assets include current assets such as cash, debtors, securities, and prepayments. Long term assets include land, machineries, plants, and furniture. On the T account liabilities are recorded on the right hand side. They include current liabilities and long term liabilities and owners equity.
Current assets: Current liabilities:
Cash xx Accounts payable xx
Accounts receivable xx Long term liabilities:
Marketable securities xx loans xx
Inventory xx bonds payable xx
Prepayments xx total liabilities xx
Total current assets xx owner’s equity xx
Long term assets: retained earnings xx
Land xx total owner’s equity xx
Plant and equipment xx total liabilities xx
Total long term assets xx
Intangible assets xx
Total other assets xx
Total assets xx
The income statement
This records revenue and expenses of a business entity for a specific period of time usually one year. Gross profit which is obtained after deducting COGS from the sales. Income before tax is obtained after deducting operating costs from gross profit. After deducting income tax from EBT, net income is obtained.
Cost of sales xx sales xx
Gross profit xx
Operating expenses gross profit b/f xx
Income before income tax xx
Net income xx
Statement of owner’s equity
This report changes in owner’s equity for specified period. Owner’s equity b/f represents owner’s equity as per last financial year, adding new investment (shares) to this, less withdrawals; one obtains owner equity for the year in consideration
Owners’ equity b/f xx
New investment xx
Net income xx
Owner equity xx
Statement of cash flows:
This records inflows and outflows of cash and cash equivalents. It shows changes in the financial position on cash basis. Cash equivalent represent assets that are convertible to cash within or less than three months
Opening balance xx cash outflows
Add cash inflows purchase of fixed assets xx
Cash from operations xx preference shares redemption xx
Sales of fixed asset xx loan repayment xx
Income from sale dividend, tax payment xx
of fixed assets xx xx
Share capita xx closing balance xx
Non trading income xx
Total xx xx
Financial statement preparation:
The first step towards preparing financial statement is recording the transactions in the journals. Then the accountant will prepare ledger accounts for every item e.g. machinery, wages, furniture, cash accounts and so on. It is from these ledgers data to prepare the basic financial statement is derived from.
Net income/loss reported in income statement forms part of owner’s equity items. If net loss results, it is deducted, if net income results then it is added (in the owner’s equity statement). Owner’s equity as at end of trading period from the owner’s equity statement is recorded in the balance sheet as owner’s capital. Net cash reported in the cash flow statement is the cash reported in the balance sheet (Carl etal 2008)
Users of financial Statement
Financial statements are very useful to managers, investors, creditors, and employees. Managers need to know performance of the business in terms of profit, costs, liquidity, and solvency status so as they appropriately plan and make decisions for future. These statements also help them in budgeting and forecasting the performance. Investors are concerned about maximization of their wealth. These statements show the dividends and other incomes rewarded. They can use the statements to judge potential earnings from the firm. Creditors offer credit facilities to a business. They use these statements to evaluate a business liquidity and solvency status so as they may be able to know ability of a business to meet its short term and long term liabilities. Employees are also concerned to know the performance of their employer. Good performance means continuation of their employment while poor performance is a threat to their employment. (Bhabatosh 2005)
Objectives of financial reporting
Financial reporting is to provide information for decision making. It is also help in forecasting, budgeting, control. Financial reporting determines financial position of a business entity. It also shows income earned. Financial reporting is meant to be used by both internal and external users.
Accounting principles, assumptions and constraints
Accounting principles includes: cost principle; which state that assets and liabilities should be reported at acquisition cost rather than market cost, Revenue principle; state that revenue should be recorded when goods pass into the possession of the buyer (when realizable or earned. Revenue should not be anticipated), matching principle; state that expenses should be matched with revenues accruing from a certain transaction, Disclosure principle; state that, any information that may affect decision making should be disclosed. (Jerry etal 2004).
Assumptions includes: Going concern; a business entity is assumed to be continuing with operations indefinitely, Business entity; this state that business and the owners are separate entities, Time period; operations of a business entity can be divided into time periods, Monetary unit assumption; a stable currency as unit of account is assumed. (Jerry etal 2004).
Constraints includes: Objectivity principle; financial statement should be objective based on evidence, Materiality principle; any item that is likely to influence decision of the financial accounts user should be included, Consistency principle; accounting principles should be used be consistently. (Jerry etal 2004).
The accounting equation is: assets =liabilities + owners’ liabilities. Business transaction leading to increase in assets will affect assets side. However this has to be funded by either owners or creditors. Meaning that, the equation will always be balanced.
Accounting reporting purpose is to provide information for decision making. Accounting standards by both international and national accounting bodies should be adhered to in financial reporting. Basic financial statements are balance sheet, cash flow statement, owners’ equity statement, and income statement. These statements are very useful to both internal and external users as far as decision making is concerned.