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Chapter 1

Introduction to Accounting Concepts and

Structure

A Brief History of Accounting

Accounting has its root in the verb "account". A standard dictionary meaning of the word is to
give a satisfactory record of money. In pre-industrial revolution feudal societies, there were
landlords who owned huge areas of land in many distant locations which were far apart. Since a
landlord could not be at all these locations for long periods of time, there arose the need to
appoint stewards at these distant locations who would look after the landlord's interests. This
resulted in the separation of ownership from control, as for most part of the year the landlord
(owner) did not get involved in operations in his lands.

Stewards had to account to the landlord and so were required to keep written records of
transactions and were required to report on all activities. This function laid the foundation for the
accountancy discipline, as we know it today. Early references to the subject of accounting are
found in the works of some ancient oriental writers. However, the systematic approach to double
entry system of bookkeeping and accounting as known today dates back to the late thirteenth
century. In 1494, Luca Pacioli a Franciscan monk living in Italy, published his well-known
work, 'Summa de Arithmetica, Geometria, Proportione et Proportionalita'. It was primarily a
study of mathematics but it also included a section on bookkeeping procedures. Since then,
accountancy has grown to become a world-renowned activity important to the functioning of the
world economy.

In Tanzania, at the time of independence in 1961, there were very few non-Europeans in
professional fields including accountancy. In recognition of the need to alleviate the shortage of
accountants and to develop an indigenous accountancy profession, the government undertook a
program of training Tanzanians overseas. Later in 1972 it developed a structure designed to
regulate and oversee the development of accounting in the country. This resulted in the
establishment of the National Board of Accountants and Auditors (NBAA) by an Act of
Parliament in 1972 (revised 2000). NBAA has all the statutory powers to regulate the accounting
profession in Tanzania. Its activities relate to all accounting related disciplines, including
government accounting, management accounting, financial accounting and auditing.

In fulfillment of its functions, NBAA releases Tanzania Financial Accounting Standards (TFAS)
and Tanzania Auditing Standards as well as some guidelines on accounting and auditing.

NBAA has also developed a Code of Ethics for Accountants and Auditors and ensures that
practitioners comply with it. It conducts examinations at all professional levels, organizes short
term training programs and seminars, and maintains a register of Certified Public Accountants.

Graduates of all accountancy training institutions must be conversant with standards and
guidelines issued by NBAA. Therefore, in this text reference will be made to sections of TFASs
and Guidelines whenever relevant to topics in discussion.

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Need for accounting information

When a business is relatively small, for example, a small shop the owner can easily manage the
business operations as well as keep record of the day to day transactions. However, as the
business organization grows complex, for example, from a small shop to a supermarket, the
owner will need to hire employees to carry out the different functions of selling, procuring
supplies, record-keeping, etc. The owner may continue to manage the business personally, but to
be able to do this effectively, the owner will need accounting information. This will enable him
to plan and make decisions regarding business operations. Therefore, periodic statements and
reports prepared from the accounting records are very essential to sound management. In
principle therefore, accounting information is needed to aid decision-making. There a number of
people, in addition to the owner, who make decisions regarding businesses. These are
collectively known as the users of accounting information.

Users of accounting information

Users of accounting information are the various parties who need accounting information in order
to make decisions, which are then communicated to others. It is for this reason that accounting is
often described as the "language of business" because it is the medium of communication
between the various parties interested in operational and financial activities of a business.
Following is a description of information interests of the different groups of users of accounting
information.

Owners/Shareholders

This group's interest in accounting information lies in the fact that it is their money which is
invested in the firm. They would like to ensure that they are getting a good return on their
investment. This is assessed by how much profit the firm is making and whether their
investment is increasing in value. For shareholders in companies this means they will get good
dividends and the market value of their shares will increase and they can make capital gains if
these were sold.

Management

Boards of Directors and Managers use accounting information for making internal decisions and
in planning business operations. They are responsible to the owners/shareholders in carrying out
policies and directives, and in running the business efficiently and effectively.

Banks/loan companies

This group is interested not only in the firm's profitability but also in its ability to repay loans.
They rely on the financial reports as the basis of assessing the firm's liquidity position and the
firm's long term likelihood of survival.

Employees

They are part of the organization and feel that their efforts contribute to a firm's profits.
Accounting information will be their basis for claiming bonus and salary increases. A stable
financial position of the firm also gives an indication of job security.

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Suppliers

Suppliers usually extend credit to the firm for goods supplied and they want to be assured of
timely payments of accounts due. Their interest in accounting information will be similar to that
of the banks and loan companies, that is, has the firm sufficient funds to pay its maturing
obligations?

Customers

The regular customers of the firm usually rely on it for steady supply of their merchandise for re-
sale or of raw materials in case of manufacturing firms. Therefore, they are interested to know if
the firm is able to continue its operations on a long-term basis and is capable of meeting its
customers' demand for goods.

Prospective Investors/Analysts

These are interested in a firm's profitability and potential for growth. Prospective investors rely
on accounting information in making their investment decisions. In giving advice to prospective
and existing investors, analysts also make use of accounting information.

Government

Various government ministries and departments have interest in firms' accounting reports as the
basis for taxation, enactment of laws for the industry and provision of social services to the
public. The government may also want to ensure that the firm complies with laws on for
example, wage payments and employee benefits.

Internal and External Users of Accounting Information

Users of accounting information fall into two broad categories; internal users and external users.
External users are those who are external to the day to day operations of the business. Internal
users are, on the other hand, those involved in the day to day operations of a business. Bankers,
Investors and Suppliers are examples of external users while managers of an entity at all levels
are internal users.

External users obtain accounting information on a business through published financial

statements. The principal published financial statements are:

a) Income Statement (Profit and Loss Account) which shows whether the business is earning
profits or sustaining losses.
b) Balance Sheet which shows the value of assets owned by the business, and how the assets
have been financed through debts and owner's equity.
c) Cash Flow Statement which shows the changes that have taken place in the cash position of
the firm, in terms of how cash has been generated and how it has been utilised during the
accounting period.

Internal users receive information in excess to what is contained in published financial reports.
Examples of these are reports on productivity levels, labour turnover, spoilage and damages, etc.
The accounting discipline has evolved specializations along the information needs of external
and internal users. The branch of accounting that focuses on information needs of internal users
is known as Management Accounting while the branch that focuses on providing information to
external users is known as Financial Accounting.
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Financial Accounting
This field of accounting is primarily concerned with the provision of financial information about
the business firm mainly to external users. As explained in the previous section these users of
financial data have diversity of interests, so that financial accounting caters to the common rather
than the specific information needs of a particular group. For this reason the financial statements
are general purpose in nature, and the accountant must adhere to prescribed standards and
principles in preparing them.

Management Accounting
This branch of accounting is mainly concerned with the provision of accounting information to
internal users, that is, the management of the firm. The kinds of financial and other reports
which management accounting offers are aimed to help management in planning and controlling
business operations, and in decision making. Cost accounting is a subset of management
accounting and has evolved because of the needs of management for accounting information on
the cost of production, pricing of products, etc. Although used mostly by manufacturing firms,
cost accounting is now in application in businesses which provide services.

Basic accounting principles

Since there are many users of accounting information and their interests are not exactly similar, it
is important that information they are provided with is uniform and contains figures all can
generally agree on. Furthermore, as these users look at information from different businesses and
over different periods of time, they need some assurance that information provided is, within
reason, accurate and comparable. This can be achieved only if financial statements are prepared
using similar approaches across businesses and over time.

For this purpose, some basic ground rules, more commonly known as accounting principles,
have been developed. Financial statements are prepared on the assumption that these rules have
been complied with.

The important basic accounting principles are as follows:

Business entity

This concept states that the business exists separately and distinct from its owners. Its books of
accounts and records should reflect only those transactions which pertain to the firm and should
not include personal transactions and activities of the owner. If the owner buys a new pair of
dress shoes it is incorrect to record this in a firm's books of account as a business expense.

Going concern

The business is assumed to continue in its operations indefinitely unless there is evidence which
indicates otherwise. In this context, the business should continue to value all its fixed assets at
original cost as it is not foreseen that they will be sold.

Accrual

Revenue should be recognized when earned rather than when cash is collected, and expenses
should be recognized when goods and services are consumed regardless of when they are paid
for.

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Matching Concept

In determining profit or loss at all times, revenues should be matched against expenses incurred
in the process of generating that revenue in the same period. It is necessary to recognize all the
revenue/income earned during a period regardless of when money is received. In the same way,
all expenses incurred by the business should be included regardless of when money is paid for
them. It is evident that the accrual and matching principles are closely connected.

Prudence

The business is encouraged to take a conservative approach in reporting its affairs. If the
accountant is faced with a choice of approaches and estimates which are all acceptable to use in
the financial statements he should take a pessimistic rather than an optimistic approach. This is
also known as the conservatism principle. A conservative view tends to underestimate rather than
overestimate assets, revenues and profits; while it overestimates rather than underestimates
liabilities, expenses and losses.

Cost

Assets of a business must be recorded at their original cost. Cost is determined through an arms-
length transaction with an independent supplier and in most cases this is the most objective
figure to use as long as the going concern assumption holds.

Unit of measure

Also known as the money measurement concept and states a position that accounting is more
concerned with activities capable of being measured in monetary terms. Therefore, money is used
as a unit of measure in recording and reporting all transactions of the business. Events and
attributes that cannot be reliably measured in monetary terms are therefore, not a major concern
of accounting. An example of such an attribute being motivation and commitment of employees.
Also inherent in this concept is the assumption that currency will remain stable in value.

Accounting Period

Although a business is assumed to continue to exist indefinitely, its life can be broken into
periods of time, usually twelve months, during which results can be measured. The significance
of this concept is that users do not have to wait until cessation of business to determine profit or
loss.

Consistency

When there are alternative accounting methods or policies which a business may use, it is
important that whichever method or policy is adopted it is used consistently from one accounting
period to another, as well as within one accounting period. If for some good reason the method
has to be changed, this should be clearly stated so that users are aware of the reason and impact
of the change.

Materiality

Only significant items should be considered when preparing financial statements. These are
items whose omission or non-disclosure will result in a distorted view of the financial statements
and will mislead the users of these financial statements. Items may be considered significant in
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amount or importance depending on the nature and size of the firm. For example, a
miscellaneous expense of shs. 100,000/= may be insignificant for a large insurance company but
significant to a sole trader.

Qualitative attributes of accounting information

In addition to complying with the basic accounting principles, accounting information must have
certain qualities for its users to attain maximum benefit from it. These qualities are Timeliness,
Relevance, Quantifiability, Verifiability/Objectivity and Understandability.

Timeliness

To have the intended benefits, accounting information should be available to the user at the
appropriate desired time so that it is incorporated in decision-making processes.

Relevance

Since the volume of accounting data which can be generated is infinite, it is important that the
provider of accounting information selects from all data available only those which are most
likely to meet needs of users of accounting information. Inclusion of irrelevant data results in
wastage of resources.

Quantifiability

Accounting information should be able to be quantified. Quantification is usually in monetary

terms although quantities other than currency are employed by accountants. This however, does
not mean exclusion of non-quantifiable qualitative factors in management decision making.

Verifiability/Objectivity

Accounting information should be measured in such a manner that two or more professional
accountants of equal competence should be able to measure the same data and arrive at
approximately similar results. Verifiable, objective information is also reliable.

Understandability

Accounting information to be useful must be understood by the different users. It has to be

presented concisely and with clarity.

Definition of accounting
There are many definitions of accounting by a number of professional bodies and authors. They
all however, revolve around the activities of generating and providing accounting information to
users so that they can make informed decisions.

The Committee on Terminology of the American Institute of Certified Public Accountants

(AICPA), defined 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."

This definition captures the various aspects that make-up the accounting process as follows:

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i. Recording of transactions and events in books of original entry.

ii. Classifying transactions through the process of posting from the books of original entry
to the different accounts in the ledger.
iii. Summarizing the results periodically in financial reports.
iv. Interpreting the results of the business operation through the analysis of financial
statements.

Bookkeeping and accounting

Bookkeeping is an activity within the broader activities of accounting. It is mainly concerned
with the recording of routine business transactions on a day to day basis. It is the record keeping
part of accounting and through this activity a business is able to determine the results of its
operations. The nature of a bookkeeper's work is clerical and may now be done using electronic
equipment. A bookkeeper may be responsible for keeping all or some of the records of a firm.

Accounting on the other hand, is concerned not only with the recording function but also with
other activities including the designing of the accounting system itself. Accountants are
responsible for preparation of financial reports and statements, as well as in the analysis and
interpretation of the reports. Accountants usually supervise the work of bookkeepers, and are
expected to have acquired a level of training and qualification commensurate to this position.

The accounting system

A system is defined in the Oxford Advanced Learners Dictionary as simply "a set or assemblage
of things connected, or interdependent, so as to form a complex unity; a whole composed of parts
in orderly arrangement according to some scheme or plan."

An accounting system is, in that context, basically composed of:

i. a set of interrelated activities involving the originating, processing and reporting of

financial and other data,
ii. written records and reports necessary to collect, process, store, and transmit information,
iii. equipment and devices used in the system to expedite the work and provide better
control, and
iv. personnel directly involved in the accounting activities.

The above components link to form an accounting system which is also influenced by variables
external to it, for example, professional accountancy organizations' influences, government
directives and new developments in the accounting discipline in other countries.

Objectives of an Accounting System

Accounting systems are designed to attain the following objectives:

i. To provide a means by which interested parties may be given information on the

financial position and results of operations of a business organization.
ii. To facilitate management planning, control and decision-making.
iii. To comply with various laws and government requirements.
iv. To protect the business and safeguard its assets.
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References
Bassett, P.H (1992) Computerised Accounting, NCC Blackwell, Manchester.
Hornby, A.S (1991) Oxford Advanced Learners Dictionary, Oxford University Press.
Hornsby, C.R (1969) in Private Enterprise and The East Africa Company, ed. Thomas, P.A,
Tanzania Publishing House, 1969.
Pacioli, L (1494) Summa de Arithmetica, Geommetria, Proportione et Proportionalita.
Koontz, H and O'Donnell,C (1974). Essential of Management, McGraw Hill.
Musselman, V.A and Hanna, J.M (1960) Teaching Bookkeeping and Accounting, Mc Graw-Hill.
NBAA (2000) Tanzania Financial Accounting Standards, National Board of Accountants and
Auditors.

Review questions
1. Define accounting. Why is accounting often called the language of business?

2. Why is the accounting function in a small shop different from a supermarket complex?

3. Why are financial statements and reports produced periodically?

4. List main groups of users of accounting information.

5. What are the qualities of good accounting information?

6. What is the relationship between bookkeeping and accounting?

7. Why are accounting principles, concepts and standards important to the accounting
function?

8. List any 10 accounting concepts you have read in the chapter.

9. Give a brief description of each of the 10 concepts you have listed above.

10. What is an accounting system and what is it designed to achieve?

Exercises
1. Why is knowledge of accounting terms and concepts useful to persons other than
accountants?

2. Information available from accounting records provide a basis for making many business
decisions. Can you list five examples of such decisions?

3. Comment briefly on each of the following statements. Your comments should indicate
whether you agree or disagree with the statement as well as reasons for your position.

(a) An accountant is merely another name for a bookkeeper. The only difference is
that an accountant goes through a college while a bookkeeper learns through
experience.
(b) Accounting information is essentially historic in nature. Thus accounting data
are useful in determining the past, but of little use in projections concerning the
future.

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(c) Computers will eventually replace the accountant.

4. Walter Milulu works for Jaribu Enterprises as an accountant. He has to make a decision
as to how stocks will be valued. Several methods are acceptable. Because one of his
friends owns the business, Walter chooses the method which results in the highest
valuation. He thinks that will put the business in a better position when applying for a
loan from the National Bank of Commerce.

Required:

Discuss this situation in terms of accounting standards covered in the chapter.

Problems
1
1. AC 100: Principles of Accounting has been a compulsory course for all Business and
Economics students at the University of Dar es Salaam for many years. The Economics
student representatives are lobbying the Heads of the Accounting and Economics
Departments to eliminate AC 100: Principles of Accounting from the Economics
programme. They have presented the following arguments in support of their position:

i) Offices are becoming highly specialised, and the majority of economists are not
required to keep any accounting records.

ii) Computerisation is rapidly taking over the accounting function in business and
the need for workers trained in bookkeeping is certain to decrease.

iii) The time the economics students now spend in the accounting course could be
more profitably spent in an additional econometric course.

iv) The accounting course has proved very difficult for many economics students.
Because of the difficulty they have with the accounting course, some students
have become discouraged and even been discontinued in their studies.

Required

Assume that you are the Lead Advisor to the Heads of the Accounting and Economics
Departments. What is your reaction to the arguments the representatives presented? Give
reasons to support your point of view.

1
This problem is an adapted version of a case problem from Teaching Bookkeeping and Accounting, Musselman,
VA and Hanna, JM, McGraw-Hill, 1960.