Module 1: Accounting Foundations

The Language of Business

Accounting is often called the language of business because it is how businesses describe what they own, what they owe, what they earned and where their cash went. Owners use it to make decisions, banks use it to decide whether to lend, investors use it to decide whether to invest, and tax authorities use it to assess tax. If you can read and write this language, you will understand businesses far better, whether you run one, work in one or invest in one.

Financial accounting and management accounting

Accounting has two main branches:

• Financial accounting records transactions and produces standardised financial statements for people outside the business, such as shareholders, lenders, regulators and tax authorities. It follows agreed rules so that statements are comparable and reliable.
• Management accounting produces information for people inside the business, such as budgets, product costings and performance reports. It can take any form that helps managers decide.

This course focuses on financial accounting: how transactions are recorded and turned into the income statement, balance sheet and cash flow statement.

Accounting standards

To make financial statements comparable, accountants follow a set of rules called accounting standards. Kenya, like many countries, has adopted International Financial Reporting Standards (IFRS), issued by the International Accounting Standards Board, and there is a simplified version for qualifying smaller entities, IFRS for SMEs. The Institute of Certified Public Accountants of Kenya (ICPAK) oversees the accountancy profession locally. Which standards apply to a particular entity depends on its type and size, so a business should confirm its reporting requirements with its accountant or auditor. In this course, you will learn the core principles that underlie all of these frameworks.

Key concepts behind the numbers

A few basic ideas shape how accountants record transactions:

• Business entity: the business is treated as separate from its owners. If the owner of a salon in Kisii pays her household electricity from the business account, that is not a business expense; it is a withdrawal by the owner.
• Going concern: statements are normally prepared on the assumption that the business will continue operating for the foreseeable future.
• Accrual basis: income is recorded when it is earned and expenses when they are incurred, not simply when cash moves. You will study this in detail later.
• Consistency: once a business chooses an accounting method, it should use it consistently so that results can be compared over time.
• Materiality: information is material if leaving it out or misstating it could influence users' decisions. Very small items may be treated simply.
• Prudence and faithful representation: statements should present the business's position faithfully, without deliberately overstating assets or income or understating liabilities.

The main financial statements

The statements are accompanied by notes that explain accounting policies and give further detail.

Worked example: reading a simple story in numbers

Brian starts a mobile phone accessories shop in Nairobi's CBD. In his first month (all figures hypothetical) he puts KES 300,000 of his savings into the business, buys stock for KES 180,000, sells goods that cost KES 120,000 for KES 200,000 in cash, and pays rent of KES 30,000.

In accounting language: owner's capital is KES 300,000; revenue is KES 200,000; cost of goods sold is KES 120,000; rent expense is KES 30,000; so profit is KES 50,000. At the end of the month he has stock of KES 60,000 and cash of 300,000 - 180,000 + 200,000 - 30,000 = KES 290,000. Total assets are KES 350,000, which equals his original capital of 300,000 plus profit of 50,000. These few sentences already contain an income statement and a balance sheet, which you will learn to prepare formally.

Common mistakes to avoid

• Mixing personal and business transactions.
• Assuming profit equals the increase in the bank balance.
• Treating accounting as only a tax requirement rather than a decision-making tool.
• Ignoring the notes and accounting policies when reading statements.