Beirut Arab University

Fall 2016-2017

Introduction to Accounting
Dr. Dima Saiid Abdul hay

Chapter I: Accounting in Action

Introduction :
In all activities (whether business activities or non-business activities) and in all
organizations (whether business organizations like a manufacturing entity or trading
entity or non-business organizations like schools, colleges, hospitals, libraries, clubs,
temples, political parties) which require money and other economic resources,
accounting is required to account for these resources. In other words, wherever money
is involved, accounting is required to account for it. Accounting is often called the
language of business. The basic function of any language is to serve as a means of
communication. Accounting also serves this function.
Accounting, as an information system is the process of identifying, measuring and
communicating the economic information of an organization to its users who need the
information for decision making. It identifies transactions and events of a specific
entity. A transaction is an exchange in which each participant receives or sacrifices
value (e.g. purchase of raw material). An event (whether internal or external) is a
happening of consequence to an entity (e.g. use of raw material for production). An
entity means an economic unit that performs economic activities.

Accounting Objectives:

Objectives of accounting may differ from business to business depending upon their
specific requirements. However, the following are the general objectives of
accounting.
i)

To keeping systematic record: It is very difficult to remember all the

business transactions that take place. Accounting serves this purpose of
record keeping by promptly recording all the business transactions in the
books of account.

ii) To ascertain the results of the operation: Accounting helps in ascertaining result
i.e., profit earned or loss suffered in business during a particular period. For this
purpose, a business entity prepares either a Trading and Profit and
Loss account or an Income and Expenditure account which shows the profit or loss of
the business by matching the items of revenue and expenditure of the same period.
iii) To ascertain the financial position of the business: In addition to profit, a
businessman must know his financial position i.e., availability of cash, position of
assets and liabilities etc. This helps the businessman to know his financial strength.
Financial statements are barometers of health of a business entity.

iv) To portray the liquidity position: Financial reporting should provide information
about how an enterprise obtains and spends cash, about its borrowing and repayment
of borrowing, about its capital transactions, cash dividends and other distributions of
resources by the enterprise to owners and about other factors that may affect an
enterprises liquidity and solvency.
v) To protect business properties: Accounting provides up to date information about
the various assets that the firm possesses and the liabilities the firm owes, so that
nobody can claim a payment which is not due to him.
vi)To facilitate rational decision making: Accounting records and financial
statements provide financial information which help the business in making rational
decisions about the steps to be taken in respect of various aspects of business.
vii) To satisfy the requirements of law: Entities such as companies, societies, public
trusts are compulsorily required to maintain accounts as per the law governing their
operations such as the Companies Act, Societies Act, and Public Trust Act etc.
Maintenance of accounts is also compulsory under the Sales Tax Act and Income Tax
Act.

Importance of Accounting to :

i)

Owners: The owners provide funds or capital for the organization. They
possess curiosity in knowing whether the business is being conducted on
sound lines or not and whether the capital is being employed properly or
not. Owners, being businessmen, always keep an eye on the returns from
the investment. Comparing the accounts of various years helps in getting
good pieces of information.

ii)

Management: The management of the business is greatly interested in

knowing the position of the firm. The accounts are the basis; the
management can study the merits and demerits of the business activity.
Thus, the management is interested in financial accounting to find whether
the business carried on is profitable or not. The financial accounting is the
eyes and ears of management and facilitates in drawing future course of
action, further expansion etc.

iii)

Creditors: Creditors are the persons who supply goods on credit, or

bankers or lenders of money. It is usual that these groups are interested to
know the financial soundness before granting credit. The progress and
prosperity of the firm, two which credits are extended, are largely watched
by creditors from the point of view of security and further credit. Profit
and Loss Account and Balance Sheet are nerve centers to know the
soundness of the firm.

iv)

Employees: Payment of bonus depends upon the size of profit earned by

the firm. The more important point is that the workers expect regular
2

income for the bread. The demand for wage rise, bonus, better working
conditions etc. depend upon the profitability of the firm and in turn
depends upon financial position. For these reasons, this group is interested
in accounting.

v)

Investors: The prospective investors, who want to invest their money in a

firm, of course wish to see the progress and prosperity of the firm, before
investing their amount, by going through the financial statements of the
firm. This is to safeguard the investment. For this, this group is eager to go
through the accounting which enables them to know the safety of
investment.

vi)

Government: Government keeps a close watch on the firms which yield

good amount of profits. The state and central Governments are interested
in the financial statements to know the earnings for the purpose of
taxation. To compile national accounting is essential.

vii)

Consumers: These groups are interested in getting the goods at reduced

price. Therefore, they wish to know the establishment of a proper
accounting control, which in turn will reduce to cost of production, in turn
fewer prices to be paid by the consumers. Researchers are also interested
in accounting for interpretation.

viii) Research Scholars: Accounting information, being a mirror of the financial

performance of a business organization, is of immense value to the research scholar
who wants to make a study into the financial operations of a particular firm.
To make a study into the financial operations of a particular firm, the research scholar
needs detailed accounting information relating to purchases, sales, expenses, cost of
materials used, current assets, current liabilities, fixed assets, long-term liabilities and
share-holders funds which is available in the accounting record maintained by the
firm.

What is Accounting?
American Institute of Certified Public Accountants (AICPA) which
defines accounting as the art of recording, classifying and
summarizing in a significant manner and in terms of money,
transactions and events, which are, in part at least, of a financial
character and interpreting the results thereof.

Definition: Accounting is an information system that

identifies, records, and communicates information about
economic events to interested users.

This definition includes three activities:

1) Identifying: selecting the economic events of an entity that
must be recorded, such as: paying rent, selling goods, buying
goods, providing services, payment of salaries, receiving cash.
2) Recording: entering the economic events into a set of
accounting records. (Record, classify, & summarize).
3) Communicating: preparing the financial reports (financial
statements) to communicate the accounting information to
interested users.

Users of financial information:

There are two broad groups of users of financial information:

External users.

Internal users.

1-Internal users: users inside the company, such as managers

(production manager, marketing manager, finance directors,
company officers) to help them to plan, organize, and run the
business.

The accountant must prepare internal reports to help the managers

do their duties.
2-External users: are individuals and organizations outside a
company who want financial information about the company such
as:
a- Creditors (suppliers or banks): they give the company a credit
(loans, goods)
b- Investors: they need the accounting information to make
decisions, such as: whether to buy or not shares from the
company.
c- Taxing authorities: they need the accounting information to
know whether the company operates within tax laws or not.
d- SEC.
e- Labor Unions.
f- Customers.
g- Regulatory agencies.

Bookkeeping distinguished from accounting

Bookkeeping usually involves only the recording of economic events
.it is therefore just one part of accounting process.
Thus, Bookkeeping function is a part of accounting process that
means recording the economic events.

Types of accounting:
There are three major types of accounting :
1) Financial accounting : provides information to decision
makers who are external to the business.
2) Managerial accounting : managers make numerous
decisions. These include (1)whether to build a new plant ;(2)
how much to spend for advertising, research and
5

development,(3) whether to lease or buy equipment and

facilities, (4) whether to manufacture or buy component parts
for inventory production or (5) whether to sell a certain
product. Managerial accounting provides information for these
decisions.
3) Tax accounting: encompasses two related functions:
Tax compliance and tax planning.
-

Tax compliance: refers to the calculation of a firm's tax

liability .this process entails the completion of sometimes
lengthy and complex tax forms.

Tax planning : takes place after a year's transactions have

been completed.

The building blocks of Accounting:

1-Ethics in financial reporting:
Ethics are standers of conduct by which actions are judged as right
or wrong, honest or dishonest, fair or not fair.

2-Generally accepted accounting principles

(GAAP):Are set of accounting standards that are generally
accepted and universally practiced. These standards indicate how to
report economic events.

The financial statements must be restricted by GAAP.

Financial statements: Balance sheet, income statement,

statement of owner's equity, statement of cash flows, and
noted disclosure.

Example of GAAP is :
o The historical cost principle: This indicates that
companies must record assets at their cost (acquisition
price).
o Revenue recognition principle : means that revenue
should be recognized when realized and when earned.
o Matching principle: dictates that efforts ( expenses)
be matched with accomplishment ( revenues ) whenever
it is reasonable and practicable to do so.
o Full disclosure principle: information about financial
position, income, cash flows, and investments can be
found in one of the following three places: (1) financial
statements , (2) notes to the financial statements and
(3) supplementary information.

3-Assumptions, such as:

a- Monetary unit assumption: only data that can be expressed in
terms of money must be included in the accounting records.
Under this assumption, it is assumed that the unit of measure ($,
L.L) is constant overtime regardless the inflation or deflation

b-

Economic entity assumption: requires that activities of the

entity be kept separate and distinct from the activities of its

owners and all other entities.
c- Going concern assumption : means that the business enterprise
will have long life.
d- Periodicity unit assumption: means that money is the common
denominator of economic activity and provides an appropriate
basis for accounting measurement and analysis.
7

 Business enterprise (forms of business

ownership):
-Proprietorship:
-

Generally owned by one person.

Often small service-type business.

Owner receives any profits, suffers any losses, and is

personally liable for all debts.

-Partnership:
-

Owned by two or more persons.

Often retail and service type business

Generally unlimited personal liability.

-Corporation:
-

Ownership divided into shares of stock

Limited Liability

Review Question
Ethics are the standards of conduct by which one's actions are
judged as:
a. Right or wrong.
b. Honest or dishonest.
c. Fair or not fair.
d. All of these options.

The basic accounting equation

Assets

Liabilities

Owners equity

The accounting equation provides the underlying framework for

recording & summarizing economic events.

 Assets:
are resources owned by the company that provide future benefits.
They are used in carrying out activities, such as: production,
consumption, sales and exchange. Examples of assets: cash, land,
equipment, building
o Assets are claimed by either creditors or owners.
o All assets provide the company with future services or
benefits.
Assets could be classified into two categories:
1- Long- term assets (fixed assets): are assets that obtained for
use in operations for long period of time, such as: land,
buildings, equipment, machines, furniture, cars, and trucks.
2- Short- term assets(current assets): are assets that in form of
cash or can be converted into cash , or used up , within a
short period of time ( one year), such as:
a) Cash (in safe and at bank)
b) Accounts receivable (AR): oral promise to collect cash,
result from selling product on account (credit sales) or
providing services on account (on credit).
c) Notes receivable (NR): written promise to collect cash.
d) Inventory: good not sold yet.
e) Supplies: papers, pens.

Liabilities:
o Liabilities are creditors' claims to assets, claims to those to
whom the company owes money (creditors).
o They are present debts or obligations to creditors that should
be paid in the future.
9

Liabilities could be classified into two categories:

1. Short -term liabilities (current liabilities): are debts that
should be paid during a period of time (one year) such as:
a) Account payable (AP): oral promise to pay cash in
the future.
Result from buying goods or services on account.
b) Note payable (NP): written promises to pay cash
in the future.
c) Expenses payable, expenses not paid yet such as:
Salaries payable, tax payable, advertising
payable, wages payable.
2. Long- term liabilities: are liabilities due after a long period of
time (more than one year) such as bonds, long -term loans,
long- term NP.

Owner's Equity:
o Is the owners claim (interest) on total assets.
o Deferred to as residual equity.
o OE = A-L
o The assets of a business are claimed by either owners or
creditors.

Sub divisions of owner's equity:

-

Capital or Investments by owners(+)

Revenues(+)
Drawing s by owners(-)
Expenses(-)
o Increases in OE result from :

1- Investments by owners: are the assets that the owners put

it in the business (owners Capital), increase owner's equity.
10

2- Revenues: amounts result from selling products or providing

services to customers. They are gross increase in OE from
business activities entered into for the purpose of earning
income. Examples: Sales, interest revenue, rent revenue, fees,
commissions, dividends.
o Decreases in OE result from :
3- Drawings by owners: are withdrawals of cash or other
assets by owners for personal use.
4-

Expenses: (Decreases in OE that result from operating the

business)

- are the Cost or assets consumed or services used in the process

of earning revenue.
Examples: Utilities expense, interest expense, rent expense,
supplies expenses, salaries expense and tax expense...

Note
Increases and Decreases in OE

Increases
Decreases

Investments
by
owners
sRevenue

Owner's
equity

Withdrawal
by
owners
Expenses

Transactions:
Are business's economic events recorded by accountants. Each
transaction has a double (dual) effect on the accounting equation.

11

- Example of a transaction: buying equipment, selling goods,

buying supplies
Rule: any transaction or event affect assets, liabilities, or owner's
equity must be recorded and vice versa.

Problem: 1-1A
Nadine's Repair Shop was started on May 1 .
Prepare a tubular analysis of the following transactions for the
month of May.
1- Invested $10,000 cash to start the repair shop.
2- Purchased equipment for $5000 cash.
3- Paid $400 cash for May office rent.
4- Received $5,100 from customers for repair service.
5- Withdrew $1000 cash for personal use.
6- Paid part- time employee salaries of $2000
7- Incurred $250 of advertising costs on account.
8- Provided $750 of repair services on account.
9- Collected $120 cash for services previously billed.

12

 The Accounting cycle :

13

 Financial Statements:
Companies prepare three financial statements from the
summarized accounting data:

1. Income Statement
May be defined as a summary of the revenue (income),
expenses, and net income of a business entity for a specific
period of time. It is results in:
o Net income : the increase in capital resulting from
profitable operation of a business ; it is the excess of
revenue over expenses for the accounting period if
revenues exceed expenses.
OR

14

o Net loss if expenses exceed revenues.

Review Question
Net income will result during a time period when:

a. Assets exceed liabilities.

b. Assets exceed revenues.
c. Expenses exceed revenues.
d. Revenues exceed expenses.

Ex: Back to the previous example; prepare the income statement,

owner's equity statement and the balance sheet.

15

2. Owners Equity Statement

Statement indicates the reasons why owners equity has
increased or decreased during the period.
Net income is needed to determine the ending balance in
owner's equity.

3. Balance Sheet
o Reports the assets, liabilities, and owners equity at a
specific date.
o Assets listed at the top, followed by liabilities and owners
equity.
16

o Total assets must equal total liabilities and owners

equity.

Review Question
Which of the following financial statements is prepared as of a
specific date?
a. Balance sheet.
b. Income statement.
c. Owner's equity statement.
d. Statement of cash flows.

Accounting Career Opportunities

a) Public Accounting: Careers in auditing and taxation
serving the general public.

17

b) Private Accounting: Careers in industry working in cost

accounting, budgeting, accounting information systems,
and taxation.
c) Opportunities in Government: Careers with the IRS, the
FBI, the SEC, and in public Colleges and universities.
d) Forensic Accounting: Careers with insurance companies
and law offices to conduct investigations into theft and
fraud.

18