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Accounting theory, Recording and Control Systems

What is financial accounting?
This is the process of tracking and recording the financial
transactions of an organisation by preparing financial statements
to report on the economic condition for a prescribed accounting

The accounting personnel should have integrity and perform

their duties with integrity, objectivity, independence and due
Integrity willing to sacrifice personal needs
Objectivity impartial and intellectually honest
Independent avoid all relations that appear impaired
Due care competent and diligent
Ethical issues in Accounting
Code of ethics
A professional accountant is required to comply with the
following fundamental principles:
a) Integrity He/she should be straightforward and
honest in all professional and business relationships.

b) Objectivity He/she should not allow bias, conflict of

interest or undue influence of others to override
professional or business judgments.
Ethical Issues in Accounting
Code of ethics (contd)
c) Professional Competence He/she has a duty to
maintain professional knowledge and skill at the level
required to ensure that a client or employer receives
competent professional service based on current
developments in practice, legislation and techniques.

d) Due Care He/she should act diligently and in

accordance with applicable technical and professional
standards when providing professional services.
Ethical Issues in Accounting
Code of ethics (contd)
f) Confidentiality He/she should not disclose any
information received in confidence to third parties without
proper and specific authority unless there is a legal or
professional right or duty to disclose.

g) Professional Behaviour He/she should comply with

relevant laws and regulations and should avoid any action
that discredits the profession
Development of Accounting
Dating back about 10,000 years, the first accounting
system probably consisted of stones used to represent

Accounting began as a simple system of clay tokens to

keep track of goods and animals, before developing
complex transactions and other financial information.
Development of Accounting
Around 7500 B.C. Mesopotamians began using clay
tokens to represent goods, such as animals, tools, food
items or units of grain.

Around 3000 B.C. the Chinese developed the abacus, a

tool for counting and calculating.
Development of Accounting
History of Accounting
In the 1340s, the city of Genoa facilitated Middle
Eastern trade which resulted in European Merchants
becoming very wealthy. As a result, there was a need for
accurate record keeping of money which led to the
development of double entry book keeping.

Development of Accounting
The Massarri accounts from the city of Genoa dated in
1340 are the oldest surviving records having the
characteristics of the double entry system and were
initially accounted for in two ledgers.

The first set of ledgers were prepared by the citys

treasury officials (Massari) and the second set of ledgers
were prepared by two Maestri Razionali in order to
check the work undertaken by the Massari.
Development of Accounting
The most important financial accounting author is Luca
Pacioli; he was a mathematician who published an
arithmetic book. He dedicated 27-pages of information on
details of calculation and recording which formed the
basis for modern day double entry accounting. This was
published in 1494 in Italy and served as a guide for
accounting profession.
Development of Accounting
In the latter years, there was a need for harmonization as
there were differences in profits/losses for companies
using domestic accounting principles as opposed to
relevant international standards. This move provided
consistency in the treatment of accounting items
internationally and boosted users confidence in the
financial statements.
Development of Accounting
1966 Accountants International study Group (AISG)
was formed to study and report on accounting practices
in countries such as Canada and the United States.

1973 International Accounting Standards Committee

(IASC). They issued the first International Accounting
Standard (IAS) in 1975 which is IAS 1 Disclosure of
accounting policies (Presentation of financial
Development of Accounting
1977 International Federation of Accountants (IFAC)
formed and replaced AISG.

2001 International Accounting Standards Board (IASB)

was established and replaced the IASC to oversee the
development of a single set of high quality standards that
require transparent and comparable information in
general purpose financial statements.
N.B.The IASB is responsible for the accounting profession and the
IFAC is responsible for setting standards on auditing, assurance,
engagements and related services in the profession.
Significance of accounting info.
Analysis of trends/ decision making information
is relevant for decision making within an organization as
it can predict future trends in the business or notify of
any issues of past activities.

Record keeping the activities undertaken, income

obtained and expenses incurred should be well kept to
ensure efficiency within the organisation.
Significance of accounting info.
Prevention and discovery of fraud this is a
method of internal control as records are checked against
policies and procedures and source documents to ensure
that the accounts are being effectively prepared.
Limitations of accounting info.
Financial information is historical so information is
presented after the event has occurred.

There can be no guarantee that the information

presented will predict future performance.

If the Generally Accepted Accounting Principles

(GAAPs) which governs the practice are not understood,
the information presented could be misleading.
Users of Accounting information
Users of Accounting Information
Managers day to day decision makers; they need to
know the financial status of the business in order to make
informed decisions.

Owners they have invested their personal money into

the business and as a result they want to be able to observe
whether or not the business is performing well
Users of Accounting Information
Prospective buyer if and when the business is being
sold, the buyer would like to ensure that the business is a
going concern (the entity will remain operational in the
foreseeable future).

Customers they are dependent on the business to be

successful and rely on them to obtain vital goods and/or
services offered.
Users of Accounting Information
The bank if the owner desires to borrow money from
the bank, they would like to ensure that (s)he is able to
repay at the opportune time.

Employees they are dependent on the success of the

business for their wages and salaries and for continued
Users of Accounting Information
The government to be able to calculate the amounts
due in taxation.

Investors these individuals need such information to

decide whether or not to invest their monies into a
particular business (potential or existing).
The Accounting cycle
The Accounting Cycle
Source Documents this is where the original information
can be found. For e.g. sales and purchases invoices, debit and
credit notes petty cash vouchers, cheque counterfoil, receipts

Journal (original) entry the raw data (transaction) is

entered in the book of original entry. i.e. the general journal
sales journal, purchases journal, sales returns journal,
purchases returns journals, cash book, petty cash book.
Journal (original entry)
The Journal used to opening record of assets, liabilities and

Sales journal (daybook) this is used to record sales

invoices and give details of the dates of the sale, name of the
customer and the amount of the sale.

Purchases journal (daybook) used to record the

purchases of the entity and gives details of the dates, supplier
and amount spent.
Journal (original entry)
Sales returns journal used to record goods returned from

Purchases returns journal used to record goods returned

to suppliers.

Cash book used to enter cash and bank transactions

(receipts and payments).

Petty cash book a cash book used to record small (petty)

The Accounting Cycle
Ledgers (T - Accounts) how the dual aspect of each
transaction is recorded. It consists of the general ledger
(records real and nominal accounts), sales ledger (debtors
accounts), purchases ledger (creditors accounts)
Real account this accounts for the personal possession (property of
all kind) of the business, for e.g. buildings, machinery, stock etc.
Nominal account this accounts for expenses and income of the
organization, for e.g. sales, purchases, wages, electricity, commissions
received etc.
The Accounting Cycle
Trial Balance this is done to periodically verify that the
transactions were recorded correctly.

Financial Statements this includes drafting and recording

information in the income statement and the statement of
financial position.
Income statement/ statement of comprehensive income
shows the gross and net profits or losses made during the period.
Statement of financial position indicates the financial position of
the business at a particular point in time.
The Accounting cycle
Statement of owners equity this shows the
changes in the amount of capital that the business owes
the owners.

Statement of cash flows shows the inflows and

outflows of money obtained and spent respectively
during the accounting period. It may be a summary of
cash receipts and payments.
Accounting methods
An accounting method refers to the basic rules and
guidelines a business undertakes for record keeping of
their financial records and to aid in the preparation of
same. There are two main accounting methods used for
The cash basis
The accruals basis
Accounting methods (contd)
The cash basis this accounting method recognizes
income and expenses according to real-time cash flow.
Income is recorded upon receipt of funds, rather than
based upon when it is actually earned; expenses are
recorded as they are paid, rather than as they are actually
Accounting methods (contd)
The accrual basis this accounting method recognizes
both income and expenses at the time they are earned or
incurred, regardless of when cash associated with those
transactions changes hands.
Under this system, revenue is recorded when it is earned
rather than when payment is received; expenses are
recorded when they are incurred rather than when
payment is made.
Cash vs. Accruals basis
The difference between both methods is concerned
with the timing to record cash coming into and going
out of the company.
E.g. Mortec Taxi Services must insure one of its motor
vehicles. The insurance company bills the entity $600
every six months (one bill in January, the next in July). If
each bill is for six months of coverage, then under the
accrual method, the accountant would not record a $600
expense in January and a $600 expense in July (doing so
would apply the cash basis) it would instead record a $100
expense each month for the whole year.
Cash vs. Accruals basis
Mortec would match the expense to the period in which it was
incurred: $100 for January, $100 for February, $100 for
March etc.

At year end however, both accounts would look similar in

terms of the total amount recorded.
Cash vs. Accruals basis
Advantages of the cash basis
It is simpler and provides a more accurate picture of cash
flow; and income is not subject to taxation until the money
is actually received.
Cash vs. Accruals basis
Disadvantage of the cash basis
Expenses and revenues are not matched in time. For e.g. A
company does painting services to a client in early April, it
sends the client an invoice in May who does not receive
payment until June. Other employees were paid for the
time they spent on the project in April and May. As a
result, the accounting records will show high expenses in
April and May with no corresponding income.
Cash vs. Accruals basis
In the previous e.g. using the accrual basis of accounting,
the income associated with the painting services would be
recorded in April, the month in which the services were
provided, even though the payment for those services may
not arrive until June. As a result, the company using an
accrual method of accounting will have records that show
expenses and revenues for the painting job in the same

Cash vs. Accruals basis

Advantage and disadvantage of the accruals basis
The advantage is that it provides a more accurate picture of
how a business is performing over the long-term.

The disadvantages are that it is more complex and income

taxes may be owed on revenue before payment is actually
Accounting standards
Accounting standards are guidelines that govern the
accounting profession which aims to achieve uniformity
and comparability of the statements. It provides a
minimum level of compliance to ensure that the quality
of the financial statements presented are good.
Accounting standards
To achieve this, special governing bodies were established
in some Caribbean countries to oversee the profession.
They include:
Bahamas Institute of Chartered Accountants (BICA)
Institute of Chartered Accountants of Guyana, Barbados,
Jamaica and Trinidad and Tobago (ICAG, ICAB, ICAJ &
Development of standards
The IASB is responsible to:
formulate and publish accounting standards to be used in
the presentation of financial statements
promote their worldwide acceptance and observation
work to improve and harmonise regulations, accounting
standards and procedures, which relate to the financial
Development of standards
After reviews and
comments, if approved, ISAB sets up a
it becomes an IAS steering committee

Outline is converted
into an exposure draft Committee identifies
and sent out for issues

Studies national &

Presents an outline
regional requirements
of the findings
and practice
IAS (our focus)
IAS 1 Presentation of financial statements
IAS 2 - Inventories
IAS 7 Statement of Cash flows
IAS 8 Accounting Policies, Changes in Accounting Estimates and errors
IAS 10 Events after reporting period
IAS 16 Plant, property and equipment
IAS 18 (IFRS 15) Revenue
IAS37 Provisions, contingent assets and liabilities.
This standard outlines the overall requirements
for financial statements;
How they should be structured
The minimum requirement for their content
Overriding concepts:
Going concern
The accrual basis of accounting
Current / non current distinctions
This standard requires that a complete set of
financial statements comprise of:
a statement of financial position (balance sheet) at the end of
the period
a statement of profit or loss and other comprehensive income
a statement of changes in equity
a statement of cash flows
notes to the financial statement, comprising a summary of
significant accounting policies and other explanatory notes
Objective of IAS 1
The objective of IAS 1 (2007) is to provide the basis for
presentation of general purpose financial statements, to
ensure comparability both with the entity's financial
statements of previous periods and with the financial
statements of other entities.

This Standard provide guidelines for recognizing,

interpreting, measuring, and disclosing specific
The financial statements must present fairly the financial
position, i.e. gives a fair representation of the financial
performance and cash flows of an entity. In applying the
IFRS, with additional disclosure it is presumed that the
financial statements have achieved a fair presentation. Also, a
statement of such compliance in the notes is required.
Financial statements cannot be described as complying with
IFRSs unless they comply with all the requirements which
includes International Financial Reporting Standards,
International Accounting Standards, IFRIC Interpretations
and SIC Interpretations).
Overriding Concept
Going concern
The standard specifies that financial statements are usually
prepared assuming the entity is a going concern and will continue
in operation for the foreseeable future. If management has
significant concerns about the entity's ability to continue as a
going concern, the uncertainties must be disclosed.

If management concludes that the entity is not a going concern,

the financial statements should not be prepared on a going
concern basis and disclosure must be made.
Overriding concept
Accrual basis of accounting
The standard requires that an entity prepare its financial
statements, except for cash flow information, using the accrual
basis of accounting.

Consistency of presentation
The presentation and classification of items in the financial
statements shall be retained from one period to the next unless a
change is justified either by a change in circumstances or a
requirement of a new IAS/IFRS.
Overriding Concepts cont
The entity is required to disclose prior period amounts in the financial
statements, both on the face of the financial statements and in the
notes. It is important that an entity present at least two of each of the
following primary financial statements:
statement of financial position*
statement of profit or loss and other comprehensive income
statement of cash flows
statement of changes in equity
related notes for each of the above items.

N.B.Where comparative amounts are changed or reclassified,

various disclosures are required.
Structure & content of fin. statements
The financial statements, must be distinguished from other information in
a published document with the following information displayed
prominently and repeated as necessary:
the name of the reporting entity and any change in the name
whether the financial statements are a group of entities or an individual entity
information about the reporting period
the presentation currency
the level of rounding used (e.g. thousands, millions).
Statement of financial position
Current and Non-current classification
An entity must normally present a classified statement of financial
position, separating current and non-current assets and liabilities.

Current assets are assets that are:

expected to be realised in the entity's normal operating cycle
held primarily for the purpose of trading
expected to be realised within 12 months after the reporting period
cash and cash equivalents (unless restricted).

NB: All other assets are non-current.

Statement of financial position contd
Current liabilities are those:
expected to be settled within the entity's normal operating cycle
held for purpose of trading
due to be settled within 12 months
for which the entity does not have an unconditional right to defer
settlement beyond 12 months (settlement by the issue of equity
instruments does not impact classification).

NB: Other liabilities are non-current (long term).

Statement of financial position..cont

NB: Where a long-term debt is expected to be refinanced under an

existing loan facility, and the entity has the discretion to do so, the
debt is classified as non-current, even if the liability would otherwise
be due within 12 months.

NB: If a liability has become payable on demand because an entity has

breached an undertaking under a long-term loan agreement on or
before the reporting date, the liability is current. However, the liability
is classified as non-current if the lender agreed by the reporting date
to provide a period of grace ending at least 12 months after the end of
the reporting period, within which the entity can rectify the breach
and during which the lender cannot demand immediate repayment.
Format of statement of Financial
The standard does not prescribe the format of the statement of
financial position. Assets can be presented current then non-
current, or vice versa, and liabilities and equity can be presented
current then non-current then equity, or vice versa. A net asset
presentation (assets minus liabilities) is allowed.
Share capital and reserves
The following disclosures should be presented as it relates to the
numbers of shares authorised, issued and fully paid, and issued but
not fully paid
par value (or that shares do not have a par value)
description of rights and restrictions
treasury shares, including shares held by subsidiaries and associates

N.B. the par value is the face value of the share.The nominal value printed
on the face of a share or bond.

The part of the capital of a company that comes from the issue
of shares.
Statement of profit or loss and other
comprehensive income
Other comprehensive income represents items of income and
expense (including reclassification adjustments) that are not
recognised in profit or loss as required or permitted by other IFRSs.

Total comprehensive income is the change in equity during a period

resulting from transactions and other events, other than those
changes resulting from transactions with owners in their capacity as

Comprehensive income for the period = Profit or loss +

Other comprehensive income
Statement of cash flows
Rather than setting out separate requirements for presentation
of the statement of cash flows, refer to IAS 7 Statement of Cash
Statement of changes in equity
The statement of changes in equity should reveal:
total comprehensive income for the period, showing separately amounts
attributable to owners of the parent and to non-controlling interests
reconciliations between the carrying amounts at the beginning and the
end of the period for each component of equity, separately disclosing:
profit or loss
other comprehensive income

The following amounts may also be presented on the face of the

statement of changes in equity, or they may be presented in the notes:
amount of dividends recognised as distributions
the related amount per share.
Notes to the financial statements
The notes to the financial statements should contain information
basis of preparation of the financial statements and the specific
accounting policies used
disclose any information required by IFRSs that is not presented
elsewhere in the financial statements that is relevant to an understanding
of any of the statements

N.B. Notes are presented in a systematic manner and cross-

referenced from the face of the financial statements to the
relevant note.
Notes to the financial statements
The notes should be presented in the following order:
a statement of compliance with IFRSs
a summary of significant accounting policies applied, including:
the measurement basis used in preparing the financial statements
the other accounting policies used that are relevant to an understanding of the
financial statements
supporting information for items presented on the face of the statement of
financial position (balance sheet), statement(s) of profit or loss and other
comprehensive income, statement of changes in equity and statement of cash
flows, in the order in which each statement and each line item is presented
contingent liabilities (see IAS 37)
non-financial disclosures, such as the entity's financial risk management
objectives and policies (see IFRS 7 Financial Instruments: Disclosures)
Other information
The following other note disclosures are required by IAS 1 if
not disclosed elsewhere in information published with the
financial statements:
domicile and legal form of the entity
country of incorporation
address of registered office or principal place of business
description of the entity's operations and principal activities
if it is part of a group, the name of its parent and the ultimate parent
of the group
if it is a limited life entity, information regarding the length of the
Statement of
Statement of
Financial Position
Statement of
Change in
Statement of Cash
Notes to the Financial
Notes to the Financial