DEMYSTIFYING ACCOUNTING: DEFINITIONS, FUNCTIONS AND REAL-WORLD APPLICATIONS.

 INTRODUCTION:

This paper is put together to share knowledge with students of accounting in high schools, tertiary institutions, accounting practitioners, managers with no or limited accounting background, and other people interested in accounting. 

DEFINITION OF TERMS:

Accounting is the art of recording, classifying, and analyzing financial transactions.

Accounting is defined by Frank Wood and Alan Sangster (Frank Wood's Business Accounting 1, 12th edition @ Pearson Education Limited 2012) as 'The process of identifying, measuring and communicating economic information to permit informed judgment and economic decisions by users of that information'.

The keywords in this definition are explained below:

1. The process of identifying: Identification means determining what transactions are to be recorded and what should not be recorded. That is items or elements of financial character or nature that are to be recorded and non-financial items or elements in nature that are not to be recorded (these are only disclosed). For example, goods purchased for cash or on credit are to be recorded whereas changes in managerial policies are not to be recorded in the books of Accounts. Analysis of the financial transactions helps with the identification. 

2. Measuring of financial data: This is the process of determining the monetary amounts at which the elements of the financial statements are to be recognized and carried in the statements of financial position, statement of income and expenditure, and other comprehensive income.  In Ghana, the functional currency for measuring financial data is the Ghana Cedis (GH¢/GHS).

3. Communicating Economic Information: This means transmitting information from one person to another, from one organization to another, or a combination of both to the shareholders and other stakeholders of the organization. Taking feedback from the users of the financial statements and engaging in vertical and horizontal communication all enhance the strategic growth of the business. Board meetings, Annual General Meetings (AGM), Semi-Annual Meetings, and other stakeholder engagements provide the platform for these discussions. 

 4. Informed Judgment: This means being able to provide an objective position in conjunction with the past and current happenings, highlighting the relevance and reliability of the information shared. Relevance and faithful representation or reliability are two key qualities financial information must have. The statement of income and expenditure account helps in this regard. This is because it compares current-year transactions with prior-year transactions. Currently, it has become even more relevant to disclose how the activities of the entity impact the environment and how the environment impacts the entity (ESG issues and Climate change issues).

5. Economic Decisions: This involves production, distribution, exchange, consumption, saving, budgeting, and investment of economic resources. Economic Decisions are made to serve the interest of the individual and the organization at large. If the decision is taken by the government, it is supposed to benefit the individuals, profit-making organizations make decisions to maximize profits and non-profit organizations eg NGOs make economic decisions to maximize the general well-being of individuals in the community and society at large. 

6. Users of the information: This refers to providing information about a reporting entity that is useful to existing and potential investors, lenders, and other creditors in making decisions about providing resources to the entity.

These users need information about:

1.     The economic resources of the entity (Assets)

2.     The claims against the entity(liability)

3.     Changes in the entity's economic resources and claims(performance).

Information about the assets and liability helps users to assess its liquidity and solvency and likely needs for additional financing as well as its going concern.

The third point helps users to understand the returns the entity has produced on its economic resources. This indicates how effectively and efficiently management has used the resources of the entity and helps to predict the future.

THE APPLICATION OF ACCOUNTING:

The identifiable items in the financial transactions are called elements of financial statements. The elements are measured because they carry monetary values. 

The elements are identified by classifying them or grouping them. 

The elements of financial statements are:

1.     Measurement of financial position in the statements of financial position; assets, liabilities and equity. 

2.     Measurement of performance in the statements of profit or loss and other comprehensive income; income and expenses.

These elements, which are five (5), are used for bookkeeping. 

WHAT IS BOOKKEEPING?

It is the process of recording the entity's financial transactions into organized accounts daily.

Contemporary bookkeeping is done using Accounting Software, like Tally, QuickBooks, Pastel, etc. Bookkeeping sits on the tenets of the three Golden Rules of Accounting.

These are:

1.     Debit all expenses and losses, and credit all income and gains.

2.     Debit the receiver, and credit the giver.

3.     Debit what comes in, credit what goes out.

CHART OF ACCOUNTS:

The Charts of Accounts are the full listing of all accounts used in an organization's accounting system. It serves as the bedrock for recording financial transactions and categorizing them into the elements of financial statements. 

They are usually grouped under each element of the financial statements. 

For example, under Assets, how many types of assets does the business have?

Under expenses, what are the expenditure lines? The Chart of Accounts is generated using codes, which represent the financial statement element to help with the recording or bookkeeping. 

At the end of each financial period, a report called the Trial Balance is generated, which comprises the Charts of Accounts and their values. 

The Trial Balance is then used for preparing the financial statements for a particular period. It is also used to prepare budgets for a particular period because they carry the current, capital, and recurrent expenditure for an accounting year. Given this, it is important to have a well-organized chart of Accounts. 

In all these, embracing consistency and staying consistent, learning, unlearning, and relearning, through periodic training, feedback taking, measuring impact, and adopting modern technology helps to improve the application of accounting. 

written by:

Jennifer Ayampoka Kukua, CA (ICAG)

April 25, 2024                                                     

#NextgenofAccountants.