Chapter 1

Part A: Accounting

Introduction to accounting

Last updated November 20266 sectionsabout 7 min read

Key takeaways

Accounting identifies, records, measures and communicates financial information about an entity so that the people who rely on it can make informed economic decisions.
Assets = Liabilities + Capital at all times, because every transaction affects at least two of the three elements by equal amounts.
Users range from management, investors and lenders to employees, KRA, customers, suppliers and the public, and each needs different information.
IFRS and IAS, issued by the IASB, govern private-sector reporting; IPSAS, issued by the IPSASB, govern the public sector; ICPAK regulates accountants in Kenya.
Concepts such as going concern, accrual, prudence and consistency explain why a transaction is treated the way it is, so learn to spot them in a described scenario.

A company secretary sits close enough to the board and to shareholders that a working grasp of accounting, not the technician's fluency a CPA needs, but enough to read and question a set of accounts, is part of the role. This chapter sets out that foundation.

The nature and purpose of accounting

Accounting is the process of identifying, recording, measuring and communicating financial information about an entity, so that those who rely on it can make informed economic decisions. It is often described as the 'language of business': a common, structured way of representing what an organisation owns, owes, earns and spends.

The accounting equation

Assets = Liabilities + Capital

Assets: What the entity owns or controls
Liabilities: What the entity owes to outsiders
Capital: The owner's residual interest, assets less liabilities

Worked computation: the accounting equation on day one (not a decided case)

Wanjiru starts a small trading business, contributing KES 500,000 cash and a delivery van worth KES 300,000. She also takes out a bank loan of KES 200,000 to help fund the business.

The loan is paid into the business, so cash is 500,000 + 200,000 = KES 700,000. Total assets = cash 700,000 + van 300,000 = KES 1,000,000. Liabilities = the bank loan of KES 200,000. Capital = Assets - Liabilities = 1,000,000 - 200,000 = KES 800,000, exactly what Wanjiru contributed.

This is the accounting equation in its simplest form, and it is the identity every double-entry transaction in the chapter on accounting procedures preserves: whatever a business does, its assets must always equal its liabilities plus capital, since every transaction affects at least two of these three elements by equal amounts.

Users of accounting information

Management

Needs detailed, timely information to plan, control and make operating decisions.

Investors and shareholders

Need information to assess risk and return, and to hold management accountable.

Creditors and lenders

Need to assess the entity's ability to repay what it owes.

Employees

Need information on job security and the employer's ability to pay wages and benefits.

Government and tax authorities (KRA)

Need information to assess tax liability and monitor compliance (see the taxation chapters).

Customers and suppliers

Need assurance of the entity's stability, particularly for a long-term trading relationship.

The public

Has an interest in an entity's contribution to the economy and community, especially a large or public-sector one.

Accounting standards

IFRS (International Financial Reporting Standards)

Set by the IASB; govern how private-sector entities recognise, measure and present transactions, so financial statements are comparable across entities and borders.

IAS (International Accounting Standards)

The IASB's predecessor body's standards, many still in force alongside newer IFRS, together forming the same body of standards.

IPSAS (International Public Sector Accounting Standards)

Set by the IPSASB specifically for government and public-sector entities (see public sector accounting in the chapter on not-for-profit organisations), adapting private-sector principles to a non-profit, budget-driven context.

Regulatory framework

ICPAK

The Institute of Certified Public Accountants of Kenya, the professional body regulating accountants in Kenya and enforcing professional and ethical standards.

IASB

The International Accounting Standards Board, which issues IFRS.

IAESB

The International Accounting Education Standards Board, which sets the education and competence requirements for the accounting profession globally.

IPSASB

The International Public Sector Accounting Standards Board, which issues IPSAS.

The Companies Act, 2015

Kenya's statute governing company formation, share capital and the preparation and filing of financial statements (see the chapter on simple company accounts), of direct relevance to a company secretary's own duties.

Professional ethics

Integrity: being straightforward and honest in professional dealings
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: not disclosing information acquired professionally without proper authority
Professional behaviour: complying with relevant laws and avoiding conduct that discredits the profession

Accounting concepts and conventions

Going concern

Assumes the entity will continue operating for the foreseeable future, unless there is evidence otherwise.

Accrual

Recognises transactions when they occur, not when cash changes hands.

Consistency

Applies the same accounting treatment from one period to the next, so results are comparable.

Prudence

Exercises caution, not overstating assets or income, nor understating liabilities or expenses.

Materiality

Includes only information significant enough to influence a user's decisions.

Business entity

Treats the business as separate from its owner(s) for accounting purposes.

Money measurement

Records only transactions expressible in monetary terms.

Historical cost

Records assets at their original cost, not current market value, unless a standard requires otherwise.

Matching (matching/accruals)

Matches expenses to the revenue they helped generate, in the same period.

Dual aspect

Every transaction has two effects, the basis of double-entry bookkeeping (see the chapter on accounting procedures).

Exam tip

The ten principles above come up constantly as 'which concept explains this treatment' questions, learn to recognise going concern, accrual, prudence and consistency from a described scenario, not just from their names. The accounting equation from the worked example above is the constant check running underneath every one of them: whichever principle a transaction illustrates, assets must still equal liabilities plus capital afterward.

Self-check

(a) Wekesa starts a business contributing KES 350,000 cash and equipment worth KES 150,000, and borrows KES 120,000 from a bank. Compute total assets, liabilities and capital. (4 marks)

(b) State three users of accounting information and, for each, one piece of information they primarily need. (6 marks)

(c) Identify the accounting concept illustrated: a business continues to value its land at its original 1990s purchase cost, not its current market value. (2 marks)

Show worked answer

(a) The loan is paid in as cash, so total assets = cash 350,000 + 120,000 + equipment 150,000 = KES 620,000. Liabilities = KES 120,000. Capital = 620,000 - 120,000 = KES 500,000, equal to what Wekesa contributed (4 marks).

(b) Any three of: management (detailed information to plan and control operations); investors and shareholders (information to assess risk, return and hold management accountable); creditors and lenders (the entity's ability to repay); employees (job security and the employer's ability to pay wages); government and tax authorities (assessing tax liability); customers and suppliers (assurance of stability for a long-term relationship) (6 marks).

(c) Historical cost: assets are recorded at their original cost, not current market value, unless a standard requires otherwise (2 marks).