CHAPTER 01 : The nature and context of accountancy

Accountancy as a concept

At one point of time, we are interacting with traders in retail shops, grocery stores, pharmacy and mobile money agents. You might have seen those traders maintaining some financial records of their transactions. Furthermore, you might have seen in some newspapers, financial reports of business entities like commercial banks showing how they have perfomed in a particular accounting period. Have you ever wondered why these practices are taking place? To whom are the published financial reports targeted? How do they make use of reported information and for which purpose or objectives? The answers to these and other related questions define what accountancy is all about. Accountancy is defined by its relevance, that is, what it can offer for those interested to learn about it and what it does in terms of supporting business management and decision making.

As a concept, accountancy is the systematic field of knowledge pertaining to accounting, including the rules and principles that govern actual accounting procedures. Thus, accounting is a subset of accountancy that involves the practical application of accountancy principles to execute the profession’s core duties. In other words, accounting tries to explain the nature of the work of the accountants (professionals) and accountancy refers to the profession these people adopt. According To American Institute of Certified Public Accountants (AICPA), accounting is 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. Four important activities are captured within this definition including the following:

1. Recording of transactions and events in books of original entry.
2. Classifying transactions through the process of posting from the books of original entry to different accounts in the ledger.
3. Summarizing the results periodically in financial reports.
4. Interpreting the results of the business operations through the analysis of financial statements.

Differences between accounting and bookkeeping

Better understanding of accounting can also be attained by comparing with bookkeeping learnt at lower- level secondary education. Accounting is much broader; it includes all the basic elements of bookkeeping as well as advanced concepts and practices. Besides the preparation of financial statements, accountants are also involved in financial statements analysis and their interpretation.

Individual with relevant accounting skills and knowledge, and can undertake accounting jobs professionally is known as accountant. Besides the recording of business transactions – the usual activity of bookkeeper – they are also engaged in summarizing and further processing of financial data to provide meaningful financial information. Due to their high level of expertise, accountants are also responsible for designing accounting systems of different organizations. In order to carry out these activities in an effective manner, accountants must be highly trained than book keepers.

Historical development of accounting

Accounting is perhaps one of the oldest and structured discipline, which has evolved in response to the changing social and economic development of the society. It is known to have existed in one form or another since at least 3,500 BC. Considerable evidence shows that, accounting was being practised in ancient times in several places e.g., Egypt, China, Greece, and Rome. One of the oldest textbooks relating to accounting is the one written by an Italian Franciscan monk and mathematics Professor, Luca Pacioli in year 1494. His book titled, Summa de Arithmetica, Geometria, Proportione et Proportionalita, translated as, summary of arithmetic, geometry, and algebra is seen by many as providing comprehensive elaborations on the use of double entry bookkeeping in ancient times. The book provides a detailed description on the rules of debits and credits in both, journals and ledgers that is still used today as basis of accounting. Due to this, he is referred by many as the father of accounting.

The popularity of accounting increased due to its information usefulness to assist in decision making and control of businesses. People needed accounting to record business transactions, know if they were being financially successful, and know how much they owned and how much they owed. For example, during the period of pre-industrial revolution, accounting was extensively used by feudal societies that had wealthy landlords who owned vast properties and wealth. These properties were scattered at many distant places thus making it difficult to maintain and control activities that were taking place in those properties. In this kind of situation, management were expected to prepare financial reports for the landlords to know what is happening with their businesses as well as how they were performing. By using these reports and physical evidence e.g., increased properties and resources like cash, management could be rewarded, demoted or replaced based on their performance.

During the industrial revolution and the development of Multinational Companies (MNCs), the world has experienced the emergence of large corporations, extending their activities beyond the countries of their incorporation. This requires the use of advanced accounting systems to provide highly sophisticated accounting information reports between individuals located in far distantly places. The role of accounting to act as medium of communication between management and external stakeholders has thus remained the same. Owners and creditors who provide necessary resources for the development of businesses consider accounting as important for understanding the performance and financial position of the businesses. This is important in supporting the achievement of different business decisions and control.

Exercise 1.1

1. What do you understand by the term accounting?
2. In what ways does accounting differ from bookkeeping?

Branches of accounting and their general objectives

There are several branches of accounting, which have emerged due to changes in economic and business development. In other words, the demands of accounting information evolved to suit the needs and objectives of different classes of persons. Conventionally, there are three branches of accounting as presented in figure 1.1.

As observed in Figure 1.1, conventionally, the three branches of accounting include financial accounting, cost accounting and management accounting. Financial accounting is concerned with recording of financial transactions and eventually reporting of financial statements that show the performance (profit or loss) over a span of time/period and financial position of the business (assets, liabilities and capital) as on a particular date. This is usually done at the end of accounting period. One of the distinctive features of financial accounting is that, accounting records and financial reporting are closely guided by well-established accounting standards, known as the International Financial Reporting Standards (IFRS), which were adopted in Tanzania by July, 2004. The information produced under financial accounting, primarily aim at meeting the information needs of external stakeholders of a business.

As for cost accounting, its early development was shaped more by its application in manufacturing firms. Primarily, it was used to record and analyse manufacturing costs with the major objective of determining the cost of products. Nowadays cost accounting is widely used in different organizational settings including, service providing firms. Contrary to financial accounting, cost accounting is not strictly guided by accounting standards (e.g., IFRS) but a variety of cost accounting principles. As for users, it is mainly used by management of the organisation to achieve the objectives of control and reduction of costs in the production of goods and services. In other words, cost accounting information is generally meant for management consumption i.e., internal use of accounting information.

Comparably, Management accounting is closely related to cost accounting as it utilises all the principles and techniques of cost accounting in data processing. However, it is relatively much broader in terms of nature of data to be processed and usage. Besides financial information it also takes into account different types of qualitative factors e.g., issues from areas of marketing and human resources. Nevertheless, as observed in cost accounting, management accounting also is not strictly guided by accounting standards. Management accounting reports such as budgets and other types of operational reports, they are normally prepared at the discretion of the management using different methods and formats provided they yield desired quality information. This is different from financial accounting; the contents and format of financial reports are given/ specified in different types of accounting standards.

As of recent, other branches/types of accounting have emerged besides the three identified ones. Examples on this include, tax accounting, forensic accounting and social responsibility accounting. For instance, Tax accounting is concerned with tax related matters including, the determination of tax liability and preparation of tax returns for individuals, companies and other entities. Tax accounting is governed by tax laws and regulations applicable in a particular country. For example, in the context of Tanzania, it is the Income Tax Act of 2004 that provide the legal framework for persons to fulfil their tax obligations. Professionals in this area namely, Tax accountants usually provide tax related services to individuals and business community. This includes, the use of legal ways to minimize tax liabilities for their clients. As for forensic accounting, this deals with the application of accounting, auditing and investigative skills in analysing financial information, which can appropriately be used as evidence in the Court of law. Experts in this area, are usually engaged in investigating financial fraud and embezzlement of funds. In contrast, social responsibility accounting is the process of communicating the social and environmental effects of an organization’s economic actions to particular interest groups within society and to society at large. In other words, social responsibility accounting focuses on financial reporting on what the business is giving back to the society in return for the benefits it enjoys from it. Arguably, the business economic actions have direct or indirect impact to different stakeholders such as employees, customers, the community and the environment in general. Due to this, the role that business plays besides its ordinary business undertakings must be of great interest to different stakeholders in the society.

Regulatory framework governing financial accounting practices

To regulate something means to exercise control over it by way of directing or governing according to a given set of rules. The regulation of the accountancy profession covers several issues. These include, entry and licensing requirements (including education requirements; monitoring of the behaviour and performance of professional accountants; the accounting standards (including ethical standards) that professional accountants must meet, disciplinary systems and procedures for those who fail to meet the requirements. For implementation and enforcement, there are different sources of rules and regulations and professional bodies, which oversee the practice and development of accounting. For example, sources of rules and regulations include the use of company laws and accounting standards. Different countries have their own company laws, which provide different conditions and rules for the establishment and operation of the companies. In the context of Tanzania, Companies Act 2002 requires that, every company registered in Tanzania to prepare a set of financial statements including, the statement of financial position (the balance sheet), statement of income (profit and loss account) and cash flow statement. Therefore, companies and their accountants are expected to comply well with the requirements specified in the regulations; otherwise, they may be penalised or punished. Examples on this include, fees or penalty for the late filing and deregistration for serious and extended defaults.

As for accounting standards, they provide different types of accounting rules to guide the preparation of financial statements. They provide the basis for recognition, measurement, presentation and disclosure of different transactions and events reported in the financial statements. For example, companies are required to report their performance (profit/loss) and financial position by using the same accounting rules (consistency) over time. This is considered as important in minimizing fraudulent manipulations and enhancing uniformity in financial reporting. It also simplifies the evaluation and comparison of performance and financial position of business entities operating in the same industry.

A country can opt to have its own locally established standards or adopt the international accounting standards. For the latter, the global International Accounting Standards Board (IASB) is the one responsible for the development and establishment of accounting standards known as International Financial Reporting Standards (IFRS). Regionally, some of the East African countries have adopted IFRS at different times. Each country has its own professional body to oversee the implementation and enforcement of accounting standards and other regulations. For example, the Institute of Certified Public Accountants of Kenya (ICPAK), the Institute of Certified Public Accountants of Uganda (ICPAU) and the Institute of Certified Public Accountants of Rwanda (ICPAR). In Tanzania, we have the National Board of Accountants and Auditors (NBAA).

At the moment, NBAA is responsible for a number of tasks including providing quality assurance review system, investigating accounting malpractices and where necessary imposing disciplinary measures to accountants and accounting professional firms. In simple words, NBAA is responsible for reviewing and checking the quality of works done by accountants making sure that, they meet all the established quality standards. Note that, accountants (including, accounting professional firms), provide different accounting related services like auditing, taxation and preparation of financial statements. Their clients, in many cases, are the businesses of different sizes. NBAA is also responsible for the development of a curriculum and administration of accounting professional examinations. To qualify as professional accountant, one is required to attend several examination sessions. The highest level of qualification is known as Certified Public Accountant (CPA). NBAA is also involved in authorization and approval of professional accountants to include, maintaining and publishing register of authorized and approved professional accountants in the country.

Exercise 1.2

1. Conventionally, what are the basic branches of accounting? Explain.

2. Due to development that has taken place, different branches of accounting have emerged beside the traditional ones.

Required

1. Identify several branches of accounting besides the traditional ones that have emerged recently.
2. What are the main objectives of different branches of accounting you have identified under (i) above?

3. By referring to the accounting profession in the context of Tanzania, explain the regulatory framework that governs the conduct of accounting.

4. Is there a need to regulate the accounting practice in Tanzania? Discuss.

Accounting information and its users Nature of accounting information

Accounting information as presented in different types of financial report provides the means through which different users of accounting information can understand the different activities taking place within the business. It does so in a unique way by reflecting the monetary values of different activities undertaken by the business. When recording in books of account, business activities are commonly referred to as business transactions i.e., business events that have monetary impact on an entity’s financial statements and recorded as entries in financial records. Examples of business activities or transactions include, paying a supplier for services rendered or goods delivered, buying office equipment by cash, and selling goods on credit.

Types of business activities reflected in accounting information

Categorically, there are three major types of business activities reflected in accounting information. They include, operating activities, financing activities and investing activities. Operating activities are the main activities that a business does to bring its products and services to the market on an ongoing basis. They depend on the nature of the business. For example, for manufacturing company these include manufacturing, selling and marketing of the products. Non-operating activities will not occur so frequently – they include one-time events that may affect revenues, expenses or cash flow but fall outside the company’s routine and core business activities. In contrast, Financing activities affect the long– term liabilities and equity/capital of the owners as a result of the flow of cash (inward and outward between a business and its owners on the one hand, and with creditors on the other hand). Examples on these include, selling of shares, adding loans, payment of dividends and interest. In contrast, investing activities include, purchases of long-term assets such as property, plant, and equipment.

They also include acquisitions of other businesses and investments in financial securities such as stocks and bonds within a specified period.

Accounting information can also be understood well by considering its key attributes or characteristics that makes it useful in decision making, as described in the following section.

Qualitative characteristics of useful accounting information

Qualitative characteristics of useful accounting information are well described in the conceptual framework of financial reporting, as revised in 2018. This provides important theory with details about the basic reasoning underlying the preparation of financial statements and reporting. Qualitative characteristics can be divided into two levels, the fundamental and enhancing qualitative characteristics. Fundamental qualitative characteristics are the basic or primary characteristics while the enhancing attributes are the additional features that add more value or they enhance more the decision usefulness of financial information.

Further details regarding the major categories and specific types of qualitative characteristics of useful accounting information are given using Table 1.1.

Table 1.1: Qualitative characteristics of useful accounting information

As indicated in table1.1, to be relevant, accounting information should be able to make impact or difference in decision making. Decision making is all about making selection between or among the given alternatives, which may include investments decisions. For example, one may have to decide whether to invest in project A or project B by considering the potential of each project in generating income. The relevance of accounting

information will be evaluated by considering its ability to show the attractiveness of each project under consideration such as the differences in revenues to be generated and cost savings.

As for faithful representation, major focus is on three attributes as shown in table 1.1, completeness, neutrality and free from material errors. Completeness underlines the basic idea that, accounting
information should be considered as faithfully represented if all pertinent information has been presented. When this is done as expected, then it will be possible for one to make a complete and accurate assessment of business performance and its financial position. On the other hand, any omissions of relevant information, would lead to a false or misleading depiction of accounting activities and phenomena thus providing incorrect picture of business performance as well as its financial position. As a result, this will render information useless to whomever use/need it to support business management or any kind of decisions. As for Neutrality, this underscore the basic idea that, accounting information should be neutral, or free from any bias. To achieve this, it is strongly forbidden to alter or present accounting information in any way that is meant to influence a decision to be made with a predetermined result in mind. The logic and justification for this; it will do good for society and accounting profession when the overall societal goals and accounting guidelines are adhered to, rather than the desires of any one person or group of people, with their own agendas. On the other hand, free from material error stresses the need or desire to keep accounting information free from error. This can be achieved by ensuring that, there are no errors and inaccuracies in the description of the phenomenon and no errors are made during the different processes of preparing financial statements. Notably, due to human nature, mistakes do occur – it is something that cannot be completely eradicated. As professional, it is advised to be careful and making sure that, one abides by the rules of conduct as well as checking or examining the data and figures used in process of preparing financial statements. This will ensure that, accounting information is accurately portrayed and reported.

It is also important to understand the key differences among the four enhancing qualitative characteristics. For instance, comparability is the quality of accounting information to enable its users to identify similarities and differences between two sets of business phenomena. It is important that, similar situations should be presented in the same manner while different situations should be presented differently. Moreover, there is a need to observe consistency, which includes, the use of the same accounting policies and procedures from one accounting period to another – within the businesses and the industry. This will facilitate the ability of users of accounting information to compare the financial statements of the business over time as well as with other similar businesses within the industry.

Verifiability, underscores the basic idea that, for accounting information to be considered as true or correct, it should be possible for one to prove/confirm whether it is true/correct. For example, during the audit assignment, auditor may cross check with the bank to see whether the bank account balance of the business being audited is the same as that shown in its balance sheet (i.e., statement of financial position). To enhance the value of verifiability, confirmation may be sought from different knowledgeable and independent parties to see whether they reach the same consensus. However, it is not necessary to have complete agreement that a particular depiction is a faithful representation. Verifiability helps users of accounting information to be assured that, information presented faithfully reflects the business transactions or events being examined. In contrast, timeliness captures the general idea that, the sooner information is available, the more useful it is. Delays in financial reporting more than expected may hinder timely access to information by decision makers, and when available it may no longer be useful to solve their decision problem.

As for understandability, this underline the basic idea that, information should be presented in a way that is readily understandable by users who have reasonable knowledge of a business and its economic activities. Understandability of accounting information is more likely to be enhanced when information is classified, characterized and presented clearly and concisely. The use of tabular or graphic formats may improve the understanding of presented accounting information. Moreover, clarifying some issues e.g., the ways in which certain financial figures have been derived and relationships between them may also enhance the clarity and understanding of key issues presented in financial reports. Additionally, it is also important to note that, ability of users to understand accounting information as presented in financial reports depend partly, on their capabilities or competencies to understand basic financial matters and the way they are displayed in financial reports.

Table 1.1 also emphasizes the importance of cost constraint, in which one is required to consider the cost and benefit of reporting certain items in the financial statements. The benefits of reporting financial information should justify and be greater than the costs imposed on supplying such information. When it is excessively expensive to report certain information in financial statements, the accounting framework allows a reporting entity (i.e., a business entity in respect of which financial reports are prepared) to avoid reporting such information.

Users of accounting information

Users of accounting information are the various stakeholders (parties or persons interested and/or concerned with the affairs of the business) who need financial information to make informed decisions. It is for this reason that, accounting is commonly referred to as the “language of business” since it acts as medium of communication between various parties involved/interested in a particular business. Users of accounting information can be classified into two categories, internal and external stakeholders. Further details on these including, specific type of users and basic objectives for demanding accounting information are presented using table 1.2.

Table 1.2: Users and their objectives for demanding accounting information

Activity 1.1

You are the owner and Managing Director (MD) of Kumekucha Company – a privately owned company that engage in manufacturing of furniture and other associated products. You have been approached by one of the subordinates (Mr. Samuel) asking whether the company will be able to restore some of the fringe benefits ceased due to financial problems that the company was facing. You are not able to provide the answers outright but you promise that, when the financial statements are issued in the next three months, they will provide the basis for deciding whether it will be possible to restore the fringe benefits, which were once stopped.

“I cannot answer your question with certainty though we have been doing well for some time now, at least for the past four months. Our contracts with several secondary schools including, Bright Future Academy and Gift Secondary Schools have enhanced our performance somehow. However, we still need to get some kind of assurance from our colleagues in the Department of Accounting. Today is 6^th April, 2022, probably by the end of July, 2022, they will be able to provide us with the early draft of financial reports. Then we can see how they can help us in this matter…”

However, Mr. Samuel probed for further information; “will it be possible to use those financial reports even before their review by external auditors? You respond to this question, “yes tentatively, they can be used to set the plans while waiting for the external auditor to finish their job”

Required

(a) Identify different individuals and entities mentioned in Kumekucha Company case as presented above, then proceed to position them within the different typologies of users of accounting information, as discussed in this chapter. You can use a matrix chart to simplify your task.

(b) Provide relevant explanations for your answer in part (a) above. Consider matching the different individuals with different typologies of users of accounting information.

(c) When the said financial statements are issued, what kind of information do you think will be of much interest for negotiating the restoration of fringe benefits between the management and other employees?

(d) Relate some of the narratives used in the given case (of Kumekucha Company) with the following qualitative characteristics of useful accounting information:

1. Relevance,
2. Timeliness,
3. Faithful representation,
4. Verifiability.
5. Supported with different sources of information (e.g. library and internet materials), who are the external auditors? Why Kumekucha Company needs them in the process of financial reporting?

Fundamental principles of accounting

Fundamental principles of accounting are the basic rules/regulations and customs that provide guidelines for the preparation of accounting records and financial statements. Since there are many users of accounting information and their interests are not similar, it is important that, information provided is uniform and contains figures, which all can generally agree on. As these users look at information from different businesses and over different periods of time, they need some assurance that, information provided is relevant and faithfully represented. To achieve this, financial statements need to be prepared using similar approaches across businesses and over time. In short, by observing the same basic principles, preparers of financial statements achieve both uniformity and consistency in the structure and quality of presented financial statements. These are critically important in making comparison on the performance and financial position of the business across time and with other similar businesses in the industry.

Fundamental principles of accounting can be divided into two classes, accounting concepts and conventions. Accounting concepts are the general rules and assumptions established by accounting bodies to guide the recording of business transactions and preparation of financial statements. They include the following: business entity, accrual basis of accounting, going concern, money measurement, accounting cost, dual aspect of accounting, accounting period, realisation and matching concept. On the other hand, accounting conventions refer to the common practices which are universally followed in recording and presenting accounting information of the business entity. One of the important differences with accounting concepts is that, accounting conventions are followed like customs and traditions in a society. They have been developed over the years, and adopted either by general agreement or common consent among accountants. In other words, accounting conventions have been evolved through regular and consistent practice over the years to achieve wider acceptance and influences the recording of books of accounts.

Four important accounting conventions, which have been used over time are; consistency, full disclosure, materiality and conservatism. The following sections describe further the different types of fundamental principles of accounting and how they affect the preparation of books of accounts.

Business Entity

A company is considered as a separate living entity or person from its owners. One can observe this by looking at different aspects of business development. For example, a company has its own name, a birth-date which is the date of incorporation (legal process of forming a company) and place of incorporation. These details are usually maintained by the institution responsible for registering companies, business names and intellectual property rights. In Tanzania, the institution responsible for this is called, the Business Registrations and Licensing Agency (BRELA). Other features of business entity include, clearly defined set of activities, regular reporting of financial affairs to the public, payment of taxes and ability to file lawsuits.

From accounting point of view, whatever the legal position or form, any business, whether a company or sole trade, qualifies to be called business entity. Therefore, the books of accounts of any type of business are expected to reflect this viewpoint i.e., as accountant you should refrain from mixing the affairs of business with those of its owners. When recording business transactions, one should not incorporate personal transactions and activities of the owner. For example, if the owner buys a new pair of khanga, trousers or shoes for personal use, it is incorrect to record this in the business’ financial records

as business expenses. The importance of of business entity includes, ability to measure properly the performance and financial position of the business as well as determining taxable income of the business. Without observing the business entity principle, the business transactions and owners personal revenue/expenses may be mixed up thus making it difficult to achieve the stated objectives.

Accrual basis of accounting

Accrual basis of accounting is the most important concept in accounting that governs the timing in recording of revenue and expenses. According to this concept, revenue should be recognised/ recorded in financial records and matched against expenses to determine profit in the financial statements, when earned rather than when cash is collected. Revenue is considered as being earned when the goods or services have been delivered to the clients. Expenses are supposed to be recognised (incurred) when goods and services are consumed in generating income rather than when actual cash is paid to suppliers of goods and services. Matching and realisation concepts are closely related with accrual basis of accounting, as explained in the following sections.

Realisation concept

The term realisation means the creation of legal right to receive money. This concept is derived from the principle of recognizing revenue. According to this principle, revenue from the sale of goods/service can only be recognized when such goods/services are delivered/ rendered to the customer. It is at this point that, revenue can be recorded in the financial records of a business.

Matching concept

According to the matching concept, the revenue and the expenses incurred to earn the revenues must belong to the same accounting period. So once the revenue is realised and expenses incurred, the next step is to allocate and match up the two to the relevant accounting period. This can be done with the help of accrual concept already explained.

Going concern

Financial statements are prepared by assuming that, the business will continue to operate for the foreseeable future unless there is evidence which indicate otherwise. In practice, the reasonable period of time, which is 12 months beyond the date when the financial statements are issued, is used to assess the going concern assumption. For example, suppose the business has difficulty in paying its debts or significant outstanding liabilities or has scaled down significant parts of operations or shut down one of its key branches. This might cast doubt on the ability of the business to continue operating as going concern and would need to be reflected in the financial statements. If there are no issues that indicate the existence of going concern problem, the business will be required to continue valuing all of its fixed assets (non–current assets) at original cost.

This is because, it is not foreseen or expected that, such assets will be sold in a near future. The valuation of assets at current value as reflected in market can only be done when the business is going to be sold or released to different person. The going concern is very important in business world because it gives investors and creditors an indicator of how long a business will be around. The concept is used to indicate the business future stability.

Money measurement

Money measurement is also known as unit of measure concept. This is concerned with how different transactions are usually captured in financial records and financial statements. Generally, only business transactions and events that are capable of being measured in monetary terms are recognised in the financial statements. Money is therefore used as the unit of measurement in different accounting records and related financial reports. Examples of unit of measurement include, but not limited to, Tanzanian shillings (TZS), Kenyan shillings (KES), Uganda shillings (UGX) and the United States Dollar (USD or $).

Cost concept

Cost concept is also known as historical cost concept. Assets of the business are usually recorded at their original cost and no adjustment is made for the changes in the market value. Cost is usually determined through business transactions in which two or more unrelated and unaffiliated parties agree to do business, acting independently and in their self-interest. Therefore, this is more likely to be objective figure to use as long as the going concern is sustained.

Dual aspect of accounting

Dual aspect of accounting is also known as double entry system. This underscores the nature of business transactions i.e., every business transaction has a dual or two aspects that must be recognized within assets, liabilities or equity. It is important to recognise both, the party giving the benefits and the one that receives the benefits. This is closely related to the basics of double entry principles i.e.; each business transaction must be recorded twice; every debit entry must have its corresponding credit entry.

Accounting period

Financial statements are usually prepared and presented to its users in periodical basis referred as accounting period. However, the normal accounting period which is also expected legally is the twelve months period. In other words, on annual basis, financial statements of a particular business will be prepared to determine its performance and financial position.

Consistency

This concept holds that, when a business selects a particular method to account for specific items, then it should continue to use that method even in subsequent accounting periods unless condition warrants a change. If, for some unavoidable reasons the method has to be changed, there should be a distinct note in the financial statements of the business giving relevant explanations so that users are informed of the reasons for such changes. This is important to enhance comparability of accounting figures over time in a meaningful manner.

Materiality

Information is considered to be material if its omission or misstatement could influence the economic decisions of users taken on the basis of the financial statements. Materiality therefore, relates to the significance of transactions, balances and errors contained in the financial statements. Materiality defines the threshold or cut-off point after which financial information becomes relevant to the decision-making needs of the users. Materiality is a relative concept depending with the size and particular circumstances of individual companies under consideration.

Full disclosure

Convention of full disclosure requires that, all material and relevant facts concerning financial statements should be fully disclosed. Full disclosure means that, there should be full, fair and adequate disclosure of accounting information. Adequate means sufficient set of information to be disclosed. Fair indicates an equitable treatment of users. Full refers to complete and detailed presentation of information. Thus, full disclosure suggests that, every financial statement should fully disclose all relevant information for all interested parties like investors, lenders, creditors and shareholders to see. This is important because, shareholders would like to know profitability of the firm while the creditors would like to know the solvency of the business. In the same way, other parties would be interested in the financial information according to their requirements. This is possible if financial statements disclose all relevant information in full, fair and adequate manner.

Conservatism

Conservatism or prudence convention is based on the principle that, one should anticipate no profit, but provide for all possible losses. When recording transactions in the books of accounts, assets and income are not to be overstated and provision/allowance should be made for all known expenses and losses whether the amount is known for certain or just an estimation. By doing so, all business expenses and liabilities will not be understated in the books of accounts. It is based on the policy of playing safe in regard to showing profit – never overstate profit. Doing so, may lead to distribution of dividend out of capital, which is not a fair policy as it will lead to the reduction in the capital of the business. Based on this convention, profit should not

be recorded until it is realised and any loss that is anticipated in the near future should be provided for. A good example on this includes, valuation of inventory whereby closing stock is supposed to be valued at cost or net realizable value, whichever is lower. Similarly, it is important to create provision/allowance for doubtful debts, discount on debtors, writing off intangible assets like goodwill and patents. The convention of conservatism is a very useful tool in situation of uncertainty and doubts.

Exercise 1.3

1. Explain the meaning and significance of the following accounting principles in preparation of accounting records and financial reporting:

1. Business entity,
2. Dual aspect of accounting,
3. Going concerns,
4. Accrual basis of accounting,
5. Consistency.

2. Assume that, rent of TZS 12,000,000 was paid on 1^st September, 2021 to cover one- year period from that date. If financial statements are prepared only on 31^st December of each year, what would be the amount of rent to be recognized as expenses on 31^st December, 2021?

Accounting information system

Generally, a system refers to a grouping of things, which are connected or interdependent forming a complex unity. A system usually has inputs, processing capability or activities and the output. Accounting information system (AIS) reflect well this definition as it is composed of different interrelated components and activities. They include, inputs (e.g., the source documents), processing (activities of transforming data from source documents into ledger accounts and preparation of financial statements) and output (generated financial statements). Technically, an AIS can be defined as a system or set of processes for collecting data about business transactions; recording, organizing, and summarizing the data, which culminates into preparation of financial statements and other reports for internal and external users.

Types/categories of accounting system

By considering the way in which information is being captured, processed and generated, AIS can be classified into manual and computerised accounting system. A manual accounting system is dominated by paperwork i.e., the use of physical records, pads of paper and books, onto which the transactions are entered by hand. In contrast, in computerized accounting system, most of the work are done using information technology (IT). In other words, computers and application programs are used to process business transactions. Nowadays, most of the businesses make use of computerized accounting system except for small scale businesses. The reasons for this include, availability of advanced technology at relatively affordable cost. In other words, computers and related application programs that help in processing and generating of financial reports are relatively inexpensive.

Components/parts and contents of AIS

Accounting information is composed of at least six basic components or parts. These include people, procedures and instructions, data, software, information technology infrastructure and internal controls. People refers to individuals who use the system, including accountants, managers and business analysts or staff. Procedure and instructions are the ways and methods used to collect, store, retrieve and process data. Data include, all the details extracted from source documents while software consists of computer programs used for processing data. Information technology infrastructure includes all the hardware (e.g., computers) used to operate the AIS while internal controls are the security measures used to protect data (e.g., passwords).

The contents of accounting system usually reflect the nature of business activities being undertaken by the company. For example, purchase of goods and services, sales of goods and services, payments to employees for wages earned, and financing activities (e.g., obtaining debt, selling shares, and paying interest to lenders). Specifically, the contents of AIS include, accounts payable, billings and accounts receivable, fixed assets, inventory and payroll. Depending on the size of the company and volume of transactions, specialized accounting staff may be employed to facilitate information processing and generation of financial statements of a business.

Activity 1.2

Make arrangement to visit any business in your local area with potential of having a section or individual dedicated to offering accounting services to that business. Have a conversation with that person to identify different activities being performed as well as facilities used in supporting bookkeeping / accounting functions. You should be keen to observe different facilities like computer, files etc., that are used to support the key functions of interest to this subject. Take note of each and everything to enable you do the following after completing the visit:

1. Write good notes to identify the main functions performed by the individual/individuals dedicated to the accounting functions in the visited organization.
2. Evaluate the accounting system in use to explain whether it is a manual or computerized accounting system?

Chapter Summary

This chapter intended to equip you with important knowledge about the nature and context of accounting. Different issues have been considered including, the meaning of accounting as a concept, brief history of the profession and branches of accounting. In order to understand the context that govern the accounting practices, the chapter has introduced the concept of regulatory framework of accounting. Different components of regulatory framework have been considered including, the International Financial Reporting Standards (IFRS), Accounting professional bodies (e.g., NBAA) and company law (Tanzania Company Act, 2002). The chapter has also introduced the concept of conceptual framework of financial reporting. This has been discussed, as the primary source of qualitative characteristics of accounting information and other financial reporting matters.

Two fundamental qualitative characteristics of useful accounting information have also been identified including, faithful representation and relevance. Besides, there are four enhancing qualitative characteristics namely comparability, verifiability, timeliness and understandability. Other important issues such as users of accounting information from within and outside the reporting entity have been considered. Examples on this include, managers and employees (internal users) and lenders, creditors and scholars (external users). The main reasons for each user groups to demand accounting information include, the decision-making usefulness of accounting information. This chapter has also provided the basic principles of accounting such as business entity, going concern and accrual basis of accounting. Moreover, the chapter provides basis for understanding how different accounting principles (concepts and conventions) guide the preparation of financial records and financial reports. The chapter has also introduced the concept of accounting system, which may be adopted by a business to facilitate the preparation of financial statements. Noted is the fact that, accounting system may either be computerised or manual depending on the level at which information technology is used to facilitate different processes involved in the preparation of financial statements. The chapter provides a number of activities and exercises to enhance student’s learning about the nature and context of accountancy.

Revision exercises

1. What do you understand by the term accountancy?

2. Why is accounting usually referred to as the language of business?

3. Differentiate the following concepts as used in accounting:

1. Accountancy versus accounting,
2. Business entity versus going concern,
3. Accrual basis of accounting versus dual aspect of accounting,
4. Consistency versus materiality, and
5. Accounting period versus cost concept.

4. Why is it important to apply fundamental accounting principles in the preparation of financial statements?

5. Identify the major categories and types of users of accounting information.

6. Think about different users of accounting information for the secondary school you are affiliated with then answer the following questions:

1. Identify the main users of accounting information for the school you are affiliated with.
2. For what purposes would the identified user groups you have identified in part (a) above need such information?

7. In what basis accounting can be differentiated from book keeping?

8. Why is understanding of accounting concepts and conventions is so important even for an ordinary business person?

9. Accounting information is important in providing valuable inputs for one to make informed decisions in different business environment.

Required

1. Explain at least ten (10) different types of decisions reflecting the real world of business.
2. How accounting information can be useful in supporting each type of decision you have explained in part (a) above?