Last updated November 20269 sectionsabout 8 min read
Key takeaways
Accounting identifies, records, classifies, summarises and communicates financial information about a business, so that the people who rely on it can make informed economic decisions.
Each user group reads the statements for its own need: owners for their return, lenders and suppliers for whether the business can pay, KRA for tax liability and compliance.
Financial statements are built from five elements: assets, liabilities, equity, income and expenses; equity is what remains of the assets after deducting all the liabilities.
IFRS and IAS, issued by the IASB, govern for-profit entities and IPSAS the public sector, so that statements prepared by different entities are comparable, consistent and reliable.
Concepts such as going concern, accrual, prudence, matching and business entity sit behind every later calculation, and accountants observe five ethical principles, from integrity and objectivity to confidentiality and professional behaviour.
Accounting is the language of business, and this opening chapter fixes its vocabulary: what accounting is for, who relies on it, and the standards, principles and ethics that keep it trustworthy.
The nature and purpose of accounting
Accounting is the process of identifying, recording, classifying, summarising and communicating financial information about a business, so that the people who rely on that information can make informed economic decisions. It exists because a business's own owners, managers and outside parties cannot otherwise reliably know how the business is actually performing or what it is actually worth.
Users and their needs
Owners/investors
Need to know profitability and the return on their investment, to decide whether to hold, buy more, or sell.
Management
Needs detailed, timely information to plan, control operations, and make day-to-day and strategic decisions.
Employees
Need information on the business's stability and profitability, bearing on job security and pay.
Lenders and creditors
Need to assess whether the business can meet its obligations, the core question behind the credit analysis this whole CCP qualification builds toward.
Suppliers
Need to know whether the business is a good credit risk before extending trade credit (CCP Credit Management, in the chapter on trade credit).
Customers
Need assurance of the business's ongoing ability to supply goods or services, particularly where they depend on it long-term.
Government and KRA
Need financial information to assess tax liability and monitor compliance with regulation.
The public
May be affected by a business's activities, employment, environment, local economic impact, and so has an interest in its financial position.
Accounting standards
IFRS (International Financial Reporting Standards)
The current set of accounting standards issued by the IASB, governing how transactions and events are recognised, measured and disclosed in financial statements of for-profit entities.
IASs (International Accounting Standards)
The predecessor standards to IFRS; many remain in force today (still numbered IAS) alongside the newer IFRS-numbered standards, both issued under the same IASB framework.
IPSAS (International Public Sector Accounting Standards)
The equivalent standards for public sector entities, covered further in the chapter on public sector accounting.
Purpose
Standards exist so that financial statements prepared by different entities are comparable, consistent and reliable, letting the users above trust and compare the numbers rather than each entity choosing its own rules.
Elements of accounting statements
Assets
Resources controlled by the entity as a result of past events, from which future economic benefits are expected to flow to the entity.
Liabilities
Present obligations of the entity arising from past events, settlement of which is expected to result in an outflow of resources.
Equity
The residual interest in the entity's assets after deducting all its liabilities, the owners' stake.
Income
Increases in economic benefits during the period, in the form of inflows or enhancements of assets or decreases of liabilities, that increase equity.
Expenses
Decreases in economic benefits during the period, in the form of outflows or depletions of assets or increases of liabilities, that decrease equity.
Qualitative characteristics
Relevance
Information is capable of making a difference to the decisions users make.
Faithful representation
Information is complete, neutral and free from error, genuinely depicting what it purports to represent.
Comparability
Information can be compared with other periods and other entities.
Verifiability
Different knowledgeable, independent observers could reach consensus that the information faithfully represents what it claims.
Timeliness
Information is available to decision-makers in time to influence their decisions.
Understandability
Information is presented clearly enough for users with a reasonable knowledge of business to comprehend it.
Concepts and conventions
Going concern
Financial statements are prepared on the assumption the business will continue operating for the foreseeable future, not that it is about to be liquidated.
Accrual
Transactions are recorded when they occur, not necessarily when cash is received or paid.
Consistency
The same accounting methods are applied period to period, so results are genuinely comparable.
Prudence
Caution is exercised so that assets and income are not overstated, and liabilities and expenses are not understated.
Materiality
Only information significant enough to influence a user's decision needs to be separately disclosed.
Business entity
The business is accounted for as separate and distinct from its owner(s), even where they are legally the same person (a sole trader, CCP Credit Management, under types of borrower).
Money measurement
Only transactions and events that can be expressed in monetary terms are recorded.
Historical cost
Assets are generally recorded at their original cost, not a fluctuating current market value.
Matching
Expenses are recognised in the same period as the income they helped generate.
Dual aspect
Every transaction has two effects on the accounting equation, the foundation of double entry book-keeping (both covered in the next chapter).
Regulatory framework
ICPAK (Institute of Certified Public Accountants of Kenya)
Kenya's professional accountancy body, which also advises kasneb on examination standards (the background to CCP Credit Management).
IASB (International Accounting Standards Board)
The independent body that develops and issues IFRS and IAS.
IAESB (International Accounting Education Standards Board)
Sets standards for the professional education and development of accountants globally.
IPSASB (International Public Sector Accounting Standards Board)
Develops IPSAS, the public sector accounting standards covered in the closing chapter.
Professional ethics
Accountants are expected to observe the same fundamental ethical principles that apply across the credit profession generally (CCP Communication and Customer Relations, in the chapter on ethics):
Integrity: being straightforward and honest in all professional and business relationships
Objectivity: not allowing bias, conflict of interest or undue influence to override professional judgement
Professional competence and due care: maintaining the knowledge and skill needed, and acting diligently
Confidentiality: respecting the confidentiality of information acquired professionally
Professional behaviour: complying with relevant laws and avoiding conduct that discredits the profession
Social and environmental accounting
Social and environmental accounting extends reporting beyond purely financial results, to an entity's impact on society and the environment: employee welfare, community impact, and environmental footprint, increasingly reported alongside, or integrated with, conventional financial statements as stakeholders demand a fuller picture of an entity's overall performance.
Exam tip
The ten accounting principles are the paper's real foundation, expect them to be tested indirectly throughout the whole syllabus (a question about depreciation is really testing prudence and matching, a question about a going-concern doubt tests them directly), not only as a standalone list.
Self-check
(a) A business recognises an expense in the same period as the income it helped generate. Identify the accounting principle this reflects. (2 marks)
(b) A supplier assessing a customer's creditworthiness relies on that customer's financial statements. Identify the user category this represents, and their specific need. (2 marks)
(c) State the five elements of accounting statements. (5 marks)
(d) Distinguish faithful representation from verifiability as qualitative characteristics. (3 marks)
Show worked answer
(a) The matching principle (2 marks).
(b) Suppliers; they need to know whether the business is a good credit risk before extending trade credit (2 marks).
(d) Faithful representation means information is complete, neutral and free from error, genuinely depicting what it purports to represent; verifiability means different knowledgeable, independent observers could reach consensus that the information faithfully represents what it claims, faithful representation is about the information's own accuracy, verifiability is about independent parties being able to confirm that accuracy (3 marks).