Sample Notes: The Purpose of Accounting

O Level Accounting — Detailed Notes
Chapter 1.1: The Purpose of Accounting

🔹 A. Book-keeping vs Accounting

1. Definition of Book-keeping

• The systematic recording of daily financial transactions of a business.
• Focuses on accuracy and completeness of records.
• Forms the foundation of the accounting process.
• Records are kept in books of original entry (e.g., sales journal, purchases journal).
• No analysis or interpretation is done at this stage.

2. Tasks Performed in Book-keeping

• Recording sales and purchases.
• Updating the cash book and petty cash book.
• Posting transactions to ledger accounts.
• Recording bank transactions.
• Ensuring double-entry system is applied correctly.

3. Definition of Accounting

• The systematic process of identifying, measuring, recording, classifying, summarising, and interpreting financial information.
• Helps in preparing final accounts such as the income statement and balance sheet.
• Involves decision-making based on financial reports.

4. Functions of Accounting

• Prepares final accounts to assess profit or loss.
• Shows financial position at a point in time.
• Provides data for budgeting and forecasting.
• Aids in compliance with legal and tax requirements.

5. Key Differences between Book-keeping and Accounting

🔹 B. Measuring Business Profit and Loss

1. Definition of Profit and Loss

• Profit: The excess of income over expenses in a specific time period.
  Formula: Profit = Total Revenue – Total Expenses
• Loss: When expenses exceed revenue.
  Formula: Loss = Total Expenses – Total Revenue

2. Importance of Measuring Profit and Loss

• Determines whether a business is successful or failing.
• Helps assess performance over time.
• Encourages better cost control and resource allocation.
• Enables owners to make investment decisions.
• Facilitates calculation of tax liabilities.
• Provides a basis for dividend declaration in companies.

3. Purpose for Different Stakeholders

• Owners: Understand profitability, decide on reinvestment or withdrawals.
• Investors: Judge return on investment and risk levels.
• Lenders (e.g., banks): Determine if the business can repay loans.
• Government: Assess tax payable.
• Employees: Check for business security and possibility of salary increases.

4. Types of Profit

• Gross Profit:
  Formula: Gross Profit = Sales – Cost of Goods Sold (COGS)
  Indicates the efficiency in production or buying/selling goods.
• Net Profit (Profit for the year):
  Formula: Net Profit = Gross Profit – Operating Expenses
  Shows overall profitability after deducting all business expenses.

🔹 C. Role of Accounting in Providing Information

1. Accounting as an Information System

• Collects data → Processes into useful reports → Helps monitor performance and make decisions.
• Provides quantitative financial data.
• Information is structured, timely, and consistent.

2. Monitoring Business Progress

• Tracks sales growth, expense patterns, asset usage, and liabilities.
• Helps compare performance month-to-month or year-to-year.
• Detects areas of concern such as:
  • Increasing expenses
  • Declining revenue
  • Poor cash flow
• Provides basis for performance evaluation using ratios (e.g., profitability ratio, liquidity ratio).

3. Decision-Making Support

• Accounting data guides decisions such as:
  • Whether to expand or shut down a branch.
  • How to price products based on cost data.
  • Whether to hire more staff.
  • How much stock to order and when.
  • Whether to purchase assets on credit or cash.
• Helps businesses prepare budgets and forecasts.

4. Role in Legal and Compliance Requirements

• Maintains records for:
  • Income Tax Returns
  • Sales Tax documentation
  • Audit trails
• Protects against fraud and provides evidence in disputes.

🔹 D. Real-Life Examples and Applications

Example 1: Small Retail Shop

• Owner uses book-keeping to record daily sales.
• Monthly accounting reports show profits after all bills and stock costs.
• Based on these reports, the owner decides to offer a discount or not.

Example 2: Large Company

• Book-keeping is handled by software that records millions of transactions.
• Management uses accounting reports to:
  • Approve budgets for marketing.
  • Identify departments with excessive costs.
  • Report performance to shareholders.
  • Make investment decisions.

🔹 E. Summary of Stakeholder Use of Accounting Information

🔹 F. Types of Accounting Information Produced

1. Financial Statements

• Income Statement: Measures profit/loss over a period.
• Statement of Financial Position: Lists assets, liabilities, and capital at a specific date.

2. Cash Flow Statements

• Tracks inflow and outflow of cash.
• Essential for maintaining liquidity.

3. Budgets

• Predict income and expenses for future periods.
• Helps in controlling overspending.

4. Variance Reports

• Show difference between budgeted and actual figures.
• Explain reasons for underperformance or overspending.

🔹 G. Limitations of Accounting

• Only quantitative data is considered; qualitative factors (e.g., employee satisfaction) are ignored.
• Historical in nature – most reports show past performance, not real-time data.
• Subject to human error if not automated.
• Some estimates (like depreciation) are based on assumptions.
• Can be manipulated to present a better image (creative accounting).

🔹 H. Common Misunderstandings in Exams

🔹 I. Keywords to Remember

• Book-keeping
• Accounting
• Profit / Loss
• Income Statement
• Financial Position
• Stakeholders
• Monitoring
• Decision-making
• Financial statements
• Revenue / Expenses
• Gross Profit / Net Profit
• Budgeting