CHAPTER ONE

INTRODUCTION TO ACCOUNTING AND BUSINESS

1.1 The Nature of Business;
A business is an organization in which basic resources (inputs), such as materials and labor, are assembled and
processed to provide goods or services (outputs) to customers. The objective of most businesses is to earn a
profit. Profit is the difference between the amounts received from customers for goods or services and the
amounts paid for the inputs used to provide the goods or services. Business activities are performed primarily
with an objective to earn profit. Business activities possess the following characteristics;
 Dealings in goods and services: businesses deal with goods and services. The goods can be of consumers
good or producer goods. The business also deals with services which are intangible and invisible.
 Production /exchange of goods and services with profit motive.
 Elements of risk and uncertainty: risk and uncertainty are two important features of business. Profit is an
incentive for taking business risks. The element of risk exists due to a variety of factors this factor can be:
 Change in demand for goods and services
 Trade cycles
 Risk of loss due firing, earthquake etc.
 Creation of utility: business makes goods and services more useful to satisfy human wants.
 Human activity: business is an activity that is only executed by human beings.
 Economic activity
 Satisfaction of customers: businesses always try to satisfy their customers with better quality goods,
reasonable price, adequate service etc.
1.2 Definition and Nature of Accounting
Accounting is defined as a process of identifying, measuring, recording and communicating economic events of
an organization (business or non- business) to interested users of the information. It provides a clear picture of
the financial health of an organization and its performance, which can serve as a catalyst for resource
management and strategic growth. It is a continuous activity or process, in which input could be processed into
final output.

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  Identifying; involves selecting those events that are considered evidence of economic activity relevant
to a particular organization. The sale of goods by ABC Super Market, the rendering of service by
Ethiopian Telecommunications Corporation, the purchase of goods and services by AKU are examples
of economic events.
 Measuring: refers to expressing the identified transaction in to monitory value.
 Recording; once identified and measured in Birr and cents, economic events are recorded in the first
permanent book of a company known as JOURNAL. Recording consists of keeping a systematic,
chronological diary of events, measured in monetary terms. Recording is done in the book called
“journal”. The recorded economic events are then classified and summarized.
 Classification; is concerned with systematic analysis of the recorded data, with a view to group
transactions or entries of one nature at one place. Items of the same kind are placed in the same account.
 Summarizing; involves presenting the classified data in a manner which is understandable and useful to
decision makers. This process leads to the preparation of trial balance and preparation of financial
statements.
 Communicating; thus, identifying and recording of activity is of little use unless the information is
communicated to interested users. The information is communicated through the outputs of the
accounting system the financial statements.
1.3 The role of accounting in business
The main purpose of accounting is to provide financial information to be used for decision-making. For
instance, Business executives and managers need the financial information provided by the accounting system
to help them plan and control the activities of the business. Outsiders such as bankers, potential investors, and
labour unions and others also need accounting information. In short the goal of the accounting system is to
provide useful information to decision makers. Thus, accounting is the connecting link between decision
makers and business operations.
Accounting can be defined as an information system that provides reports to users about the economic activities
and condition of a business. As accounting plays an important role in the decision making process of business
entities, by providing financial information about an organization’s economic activities which is intended to be
used as a basis for decision making, it is often called “the language of business”.
1.4 The profession of Accounting
If you just joined the accounting profession, you may be wondering what job you will be doing in the future.
You probably would apply your expertise in one of three major fields:
1. Public Accounting
2. Private Accounting or

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 3. Not – for – profit Accounting
Public accounting
In Public Accounting you would offer expert service to the general public in much the same way that a doctor
serves patients and a lawyer serves clients. A major portion of public accounting practice is involved with
Auditing. In this area, a certified Public Accountant (CPA) examines the financial statements of companies and
expresses opinion as to the fairness of presentation. When presentation is fair, users consider the statements to
be reliable.
Management consulting is another area of public accounting. In this case, the accountant consults the
management generally about the growth and development of the business enterprise.
Private Accounting
Instead of working in public accounting, an accountant may be an employee of a business enterprise. In private
accounting, you would be involved in one of the following activities:
Cost Accounting: Determining the cost of producing specific products.
Budgeting: Assisting management in quantifying goals concerning revenues, costs of goods sold, and
operating expenses.
General Accounting: recording daily transactions and preparing financial statements and related
information.
Accounting information systems: designing both manual and computerized data processing systems.
Tax Accounting: preparing tax returns (-forms to be filled by a company and returned to a taxing authority) and
engaging in tax planning for the company.
Internal Auditing: reviewing a company’s operations to determine compliance with management policies and
evaluating efficiency of operations.
Not for Profit Accounting
Like businesses that exist to make a profit, not - for-profit organizations also need sound financial reporting and
control. Donors to such organizations want information about how well the organization has met its objectives
and whether continued support is justified. In each of these cases, accounting expertise is highly valued.
1.5 Types of business organizations
There are three basic forms of business organizations: sole proprietorships, partnerships, and corporations.
Accountants recognize each form as an economic unit separate from its owners (Business Entity Concept).
1. Sole Proprietorships
A sole proprietorship is a business owned by one person and usually managed by the owner. No special legal
requirements must be met to start a sole proprietorship and usually only a limited investment is required to
begin operations.

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A sole proprietorship is a separate entity for accounting purposes, but it is not a separate legal entity from the
owners. That is, from the legal point of view, the owner and the business are treated as one and the same. The
owner will be held personally responsible for the debts and actions of the business. Some characteristics sole
proprietary businesses include the following:
 Simple to form; there are no legal restrictions or forms to file.
 Unlimited liability; the owner is personally liable for any debts or legal claims against the company.
Thus, creditors can take the personal assets of the owner if the business debts exceed the owner’s
investment in the company.
 Not taxable; for federal income tax purposes, a proprietorship is not taxed. Instead, the company‟s
income or loss is “passed through” to the owner‟s individual income tax return.
 Limited life; when the owner dies or retires the proprietorship ceases to exist.
 Limited ability to raise capital (funds); the ability to raise capital (funds) is limited to what the owner
can provide from personal resources or through borrowing.
2. Partnerships
A Partnership is like a sole proprietorship in most ways except that it has more than one owner. A partnership
is not a legal entity separate from the owners but an association that brings together the talents and resources of
two or more people. The owners of a partnership are known as partners.
The partners share the profits and losses of the partnership according to an agreed –on formula. The personal
resources of each partner can be called on to pay the obligations of the partnership. That is, each partner is
personally responsible for the debts of the partnership. From an accounting standpoint, however, a partnership
is a business entity separate from the personal activities of the partners, like that of the sole proprietary business.
Some characteristics partnership businesses include the following:
 Unlimited liability; the partners are personally liable for any debts or legal claims against the company.
Therefore, creditors can take the personal assets of the partners if the business debts exceed the partners‟
investment in the company.
 Not taxable; for federal income tax purposes, a partnership is not taxed. Instead, the company‟s income
or loss is “passed through” to the partners‟ individual income tax returns. However, partnerships must
still report revenues, expenses, and income or loss annually to the Internal Revenue Service.
 Limited life; when a partner dies or retires the partnership ceases to exist. Likewise, the admission of a
new partner dissolves the old partnership, and a new partnership must be formed if operations are to
continue.
 Limited ability to raise capital (funds); the ability to raise capital (funds) for the company is limited to
what the partners can provide from personal resources or through borrowing.
 Co-ownership of partnership property; the property invested in a partnership by a partner becomes the
joint property of all the partners..
 Mutual agency; each partner is an agent of the partnership and may act on behalf of the entire
partnership. Thus, any liabilities created by one partner become liabilities of all the partners.

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  Participation in income; net income and net loss are distributed among the partners according to their
agreement. If the partnership agreement does not provide for distribution of income and losses, then
income and losses are divided equally among the partners.
3. Corporations
A business organized as a separate legal entity with ownership divided into transferable units of capital called a
corporation. The owners of a corporation are called stockholders or shareholders. The corporation issues
capital stock certificates to each stockholder showing the number of shares (or stock) he or she owns. The
stockholders are free to sell all or part of these shares to other investors at any time. This ease of transfer of
ownership adds to the attractiveness of investing in a corporation. Since a corporation is a separate legal
entity, the owners (stockholders) are not personally liable for the debts of the corporation. Their risk of loss is
limited to the amount they paid (invested). Because of this limited liability in a corporation shareholders are
willing to invest in riskier, but potentially more profitable, activities. Even though corporations are fewer in
number than proprietorships and partnerships, they contribute a lot to the economies of many countries in
monetary terms. Some characteristics corporations include:
 A corporation is a separate legal entity; according to the law a corporate entity may own property in its
own name, may enter into contract and responsible for its own debt. A corporation is a separate legal
and accounting entity.
 A corporation has a legal status in court; according to the law a corporation may sue and be sued as if it
were a real person.
 A corporation has its own charter; a corporation is created by obtaining charter from the state is which
the company is to be incorporated.
 A corporation pays income taxes on its earnings; the income of a corporation is subject to income taxes
which must be paid by the corporation. In addition share holders pay taxes on dividends when declared
and paid by the corporation. There is a problem of double taxation.
1.6 Overview of International Financial Reporting Standards (IFRS);
A widely accepted set of rules, conventions, standards, and procedures for reporting financial information, as
established by the Financial Accounting Standards Board (FASB) are called Generally Accepted Accounting
Principles (GAAP). These are the common set of accounting principles, standards and procedures that
companies use to compile their financial statements. GAAP are a combination of standards (set by policy
boards) and simply the commonly accepted ways of recording and reporting accounting information. GAAP is
to be followed by companies so that investors have an optimum level of consistency in the financial statements
they use when analyzing companies for investment purposes. GAAP cover such aspects like: business entity
concept, going concept, cost principle, monetary value, accounting period, and revenue recognition etc.
Generally GAAPs are issued, by FASB, which US based board. However; there are also UK based, Japanese
based and other GAAPs. These different GAAPs are bases for the development of International Financial
Reporting Standards (IFRS).

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International Financial Reporting Standards (IFRS) are a set of accounting standards developed by the
International Accounting Standards Board (IASB). They provide a common global language for business affairs
to ensure financial statements are understandable and comparable across international boundaries.
IFRS are a set of accounting standards used globally to ensure consistency, comparability, and transparency in
financial reporting.
The objective of IFRS involves:
 Enhance transparency and comparability of financial statements.
 Provide relevant, reliable, and timely information to users.
 Facilitate cross-border investments and business transactions.
The following are some of the key principles of IFRS
 Fair presentation: Financial statements should present a true and fair view of the entity's financial
position, performance, and cash flows.
 Substance over form: Emphasizes economic substance rather than legal form I accounting transactions.
 Materiality: Information is material if its omission or misstatement could influence the economic
Similarities and differences between GAAPs and IFRS
Similarities:
 Financial Reporting Objectives: Both IFRS and GAAP aim to provide users of financial statements with
relevant, reliable, and comparable information to make informed economic decisions.
 Fundamental Accounting Concepts: Both frameworks adhere to basic accounting principles such as
accrual accounting, going concern assumption, consistency, and materiality.
 Financial Statement Components: Both IFRS and GAAP require the preparation of common financial
statements, including the balance sheet, income statement, statement of cash flows, and statement of
changes in equity.
 Disclosure Requirements: Both frameworks have extensive disclosure requirements to ensure
transparency and provide additional information to users beyond the financial statements.
Differences:
 Authority and Jurisdiction: GAAP is primarily used in the United States and is developed by various
standard-setting bodies such as the Financial Accounting Standards Board (FASB) and the Securities
and Exchange Commission (SEC). In contrast, IFRS is developed and maintained by the International
Accounting Standards Board (IASB) and is used in many countries around the world.
 Principles vs. Rules-Based: GAAP is often considered more rules-based, providing specific guidance
and detailed rules for accounting treatments. IFRS, on the other hand, is principles-based, focusing on
overarching principles and allowing for more judgment and interpretation by preparers.
 Inventory Valuation: Under GAAP, inventory can be valued using either the first-in, first-out (FIFO)
method or the last-in, first-out (LIFO) method. However, IFRS prohibits the use of the LIFO method.
 Revenue Recognition: While both frameworks follow similar principles for revenue recognition, there
are differences in specific requirements. For example, IFRS has a single, comprehensive standard on
revenue recognition (IFRS 15), whereas GAAP has multiple standards and industry-specific guidance.
 Financial Statement Presentation: IFRS allows for greater flexibility in the presentation of financial
statements, such as the option to present items in the statement of comprehensive income either as a

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 single statement or as two separate statements (income statement and statement of comprehensive
income). GAAP generally requires a single, combined statement of comprehensive income.
 Treatment of Financial Instruments: IFRS and GAAP have different classification and measurement
criteria for financial instruments, particularly in the areas of impairment and hedge accounting.
Understanding these similarities and differences is crucial for companies operating in multiple jurisdictions or
preparing financial statements for users who may follow different accounting frameworks.
Generally GAAPs or Accounting principles and standards cover such aspects like: business entity concept,
going concept, cost principle, monetary value, accounting period, and revenue recognition etc.
1. Business entity concept:
The Business Entity Concept, also known as the Entity Concept or Separate Entity Concept, is a fundamental
accounting principle under Generally Accepted Accounting Principles (GAAP). It states that a business entity is
distinct and separate from its owners, shareholders, or other entities.
Key points about the Business Entity Concept:
1. Separate Legal Entity: According to this concept, a business is treated as a separate legal entity from
its owners. This means that the business's financial transactions and activities are accounted for
separately from those of its owners.
2. Financial Reporting: The Business Entity Concept requires that financial transactions of the business
should be recorded and reported independently of the personal finances of its owners. This ensures
transparency and accuracy in financial reporting.
3. Ownership and Control: Even though owners may have a stake in the business and exercise control
over its operations, their personal financial transactions and assets are kept separate from those of the
business.
Overall, the Business Entity Concept ensures that businesses are treated as distinct entities for accounting and
financial reporting purposes, helping to maintain clarity, transparency, and accountability in business
transactions.
2. Objectivity concept
The objectivity concept in accounting emphasizes the importance of reliability and impartiality in financial
reporting. It requires that financial information be based on verifiable evidence and free from bias or personal
opinions. This ensures that financial statements provide a true and fair view of a company's financial position
and performance.
3. Going concern concept:
The Going Concern Concept is a fundamental accounting principle that assumes a business will continue to
operate indefinitely unless there is evidence to the contrary. It implies that the business entity will not be forced
to halt operations or liquidate in the foreseeable future.

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Under this concept, financial statements are prepared with the assumption that the business will continue its
operations in the foreseeable future. This assumption allows assets to be valued based on their long-term
usefulness rather than their liquidation value.
The Going Concern Concept allows assets to be valued based on their capacity to generate future economic
benefits rather than their immediate market value. For example, fixed assets are recorded at historical cost less
accumulated depreciation, rather than at their current market value.
If there are significant uncertainties about the entity's ability to continue as a going concern, these uncertainties
must be disclosed in the financial statements. Such disclosures provide transparency to users of the financial
statements and help them assess the entity's viability.
4. Cost principle:
The Cost Principle, also known as the Historical Cost Principle, is a fundamental accounting principle that
requires assets to be recorded at their original cost when acquired, rather than at their fair market value or
replacement cost.
Under the Cost Principle, assets are initially recorded in the accounting records at the amount paid to acquire
them, including all costs necessary to bring the asset to its intended condition and location for use. This includes
purchase price, transportation costs, installation costs, and any other directly attributable costs.
Cost Principle provides a reliable and objective basis for asset valuation in financial reporting, ensuring
consistency and comparability across different entities and accounting periods.
5. Monetary unit concept:
The monetary unit assumption requires that companies include in the accounting records only transaction data
that can be expressed in money terms. This assumption enables accounting to quantify (measure) economic
events. The monetary unit assumption is vital to applying the cost principle.
6. Accounting period concept:
The accounting period concept refers to the idea that a business's financial activities should be divided into
specific time periods for reporting purposes, typically a fiscal year or quarter or a month. This allows for better
organization, analysis, and comparison of financial data over time.
7. Revenue recognition principle:
The recognition concept in accounting is the principle that revenue and expenses should be recognized
(recorded) in the financial statements when they are earned or incurred, regardless of when the cash is actually
received or paid. Revenues are recognized when earned and expenses are recognized when incurred. This
ensures that financial information accurately reflects the economic reality of a business's activities during a
given period.

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 8. The matching principle:
The matching principle is an accounting concept that requires expenses to be recognized in the same period as
the related revenues they help to generate. This principle ensures that the costs incurred to generate revenue are
properly matched with the revenue earned during a specific accounting period, resulting in a more accurate
depiction of a company's profitability.
9. Principle of adequate disclosure:
The adequate disclosure principle in accounting states that financial statements should include all necessary
information for users to make informed decisions. This principle emphasizes transparency and requires
companies to disclose significant financial information, including accounting policies, contingent liabilities, and
related party transactions. The goal is to provide stakeholders with a clear understanding of a company's
financial position and performance.
10. Consistency principle
The consistency principle in accounting states that once an accounting method or practice is chosen, it should be
consistently applied over time. This ensures that financial statements are comparable from one period to
another, allowing users to analyze trends and make informed decisions. Changing accounting methods
frequently can obscure the true financial performance of a business and undermine the reliability of its financial
statements.
11. The materiality principle:
The materiality concept in accounting asserts that financial information should only be disclosed if omitting it
could influence the decisions of users of the financial statements. In other words, information is considered
material if its omission or misstatement could impact the economic decisions of users.
1.7 Overview of financial reporting requirements in Ethiopia and AABE
Financial reporting is the last step in the accounting cycle. Financial information is communicated to interested
users through the financial statements. Financial statements provide viable information for interested users to
make rational decisions. Financial statements help managers to evaluate the healthy and profitability of
businesses. They also provide necessary information current and potential investors and creditors to make
informed decisions.
Financial reporting requirements in Ethiopia are governed by the Accounting and Auditing Board of Ethiopia
(AABE). AABE sets the standards for financial reporting practices in the country.
Ethiopian companies are required to comply with the Ethiopian Financial Reporting Standards (EFRS), which
are based on International Financial Reporting Standards (IFRS) with some local adaptations.
Based on the AABE guidance Ethiopian companies must prepare and present financial statements annually.
These typically include:

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  Balance Sheet: Shows the company's financial position at a specific date, including assets, liabilities,
and equity.
 Income Statement: Reports the company's financial performance over a period, showing revenues,
expenses, and net income or loss.
 Cash Flow Statement: Details the company's cash inflows and outflows during a period, categorizing
activities into operating, investing, and financing activities.
 Statement of Changes in Equity: Illustrates changes in equity over a period, including share transactions
and retained earnings.
In addition Ethiopian financial reporting standards emphasize the importance of providing adequate disclosures
in financial statements. This includes information on significant accounting policies, contingencies, related-
party transactions, and other relevant information necessary for users to understand the financial position and
performance of the company.
According the standard Ethiopian companies are required to have their financial statements audited by a
licensed auditor registered with the Ethiopian Accounting and Auditing Board. The auditor must express an
opinion on whether the financial statements are prepared in accordance with the applicable financial reporting
framework and present fairly, in all material respects, the financial position and performance of the company.
An Overview of the Accounting and Auditing Board of Ethiopia (AABE)
The Accounting and Auditing Board of Ethiopia (AABE) is a regulatory body responsible for setting
accounting and auditing standards, overseeing the accounting and auditing profession, and promoting high-
quality financial reporting practices in Ethiopia. Here's an overview of the AABE:
The AABE is established under the Ethiopian Financial Reporting Proclamation and operates under the
Ministry of Finance. It has the authority to develop, issue, and enforce accounting and auditing standards in
Ethiopia.
AABE's overarching goal is to promote transparency, accountability, and integrity in financial reporting and
auditing practices in Ethiopia. By establishing and enforcing robust standards, the AABE aims to enhance
investor confidence, facilitate access to capital, and contribute to the overall economic development of the
country.
AABE sets accounting and auditing standards applicable to various entities in Ethiopia, including companies,
nonprofit organizations, and government entities. These standards are based on international best practices, with
local adaptations where necessary to suit Ethiopian legal and economic environments.
AABE oversees the accounting and auditing profession in Ethiopia by licensing and regulating accounting firms
and individual auditors. It establishes criteria for obtaining and maintaining professional licenses, conducts
quality assurance reviews, and takes disciplinary actions against non-compliant practitioners.
AABE plays a key role in enhancing the capacity and competency of accounting and auditing professionals in
Ethiopia. It provides training programs, seminars, and workshops to promote continuous professional

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development and ensure practitioners are equipped with the necessary skills and knowledge to uphold
professional standards.
AABE collaborates with international accounting and auditing bodies to stay updated on global developments
and best practices. This collaboration enhances the alignment of Ethiopian standards with international norms
and facilitates recognition of Ethiopian accounting qualifications internationally.
1.8 The accounting equation and elements of the equation
Accounting is the language of business, and the basic accounting equation is its foundation. The equation
represents the fundamental relationship between a company's assets, liabilities, and equity.
The basic accounting equation is expressed as:
Assets = Liabilities + Owners’ Equity (Capital)
This equation represents the fundamental relationship between a company's resources (assets), obligations
(liabilities), and ownership interest (equity). The equation must always balance, ensuring that the total value of
assets equals the total value of liabilities and equity.
Components of the accounting equation:
1. Assets:
 Assets are what the business owns
 Assets are economic resources owned or controlled by the company.
 Assets represent the company's capacity to generate future economic benefits.
 An asset represents future economic benefits.
 An asset is anything of value owned by the business
Example of assets: They are classified into current assets (e.g., cash, inventory, accounts receivable) and non-
current assets (e.g., property, plant, equipment, intangible assets).
2. Liabilities
 Liabilities are what the business owes
 Liabilities are obligations or debts owed by the company to external parties.
 Liabilities represent the company's financial obligations that must be settled in the future using its
assets
 Liabilities represents future economic sacrifices
 Liabilities represents amounts owed to creditors
Examples of liabilities: They encompass current liabilities (e.g., accounts payable, short-term loans) and non-
current liabilities (e.g., long-term loans, bonds payable).
3. Owners’ Equity (Capital)
 Equity represents what the business worth
 Equity represents the residual interest in the company's assets after deducting its liabilities.
 It comprises various components, including common stock, additional paid-in capital, retained
earnings, and accumulated other comprehensive income.
 Equity reflects the owners' claim on the company's assets and represents their ownership stake.
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  Equity reflects the residual interest in the company's assets after deducting liabilities.
 Since the claims of creditors must be paid before ownership claims, owner’s equity is often referred
to as residual equity
In general the basic accounting equation serves as the foundation for double-entry bookkeeping, where every
transaction affects at least two accounts to ensure the equation remains balanced. It helps in analyzing the
financial position of a company and assessing its liquidity, solvency, and overall financial health.
Understanding the equation is essential for financial statement preparation, interpretation, and analysis.
The balance sheet, one of the primary financial statements, is structured based on the basic accounting
equation. Assets are listed on the left-hand side, while liabilities and equity are listed on the right-hand side,
ensuring the equation remains balanced.
1.9 Business transactions and financial statements
Definition of business transactions:
Business transactions are economic events that occur within a business entity, involving the exchange of goods,
services, or resources, typically with another party, resulting in a measurable impact on the financial position of
the business.
Nature of Business Transactions:
Examples of business transactions:
 Investing transactions, depositing cash into bank accounts of new businesses.
 Sales transactions: Involving the exchange of goods or services for money.
 Purchase transactions: Involving the acquisition of goods or services in exchange for money.
 Payment transactions: Involving the transfer of money in exchange for goods or services.
 Receipt transactions: Involving the receipt of money from a customer for goods or services provided.
 Consumption of goods or services (internal transaction)
Elements of a Business Transaction:
The following are the major parties involved in a business transaction:
 There are usually two Parties involved: Buyer and seller or payer and payee.
 Goods or services exchanged: What is being bought or sold.
 Consideration exchanged: The value given by each party in the transaction.
Classification of Business Transactions:
Transaction in general can be classified as external or internal transactions
 External Transactions: Involving parties outside the business entity, such as customers, suppliers, or
creditors.
 Internal Transactions: Occurring within the business entity, such as transfers between departments or
subsidiaries, or the consumption of goods or services
 Revenue Transactions: Generating revenue through sales or services rendered.

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  Expense Transactions: Incurring costs for goods or services consumed.
 Investing Transactions: Involving the acquisition or disposal of long-term assets or investments.
Recording Business Transactions
Transactions must be recorded following generally accepted accounting principles (GAAP) or International
Financial Reporting Standards (IFRS). In a double-entry bookkeeping each transaction affects at least two
accounts, with debits and credits recorded to maintain the balance of the accounting equation inbalance. (Assets
= Liabilities + Equity).
Example -1: Assume that Misses Hewan has decided to run her own business, naming it Hewan Beauty Salon.
She has opened a bank account by the mane of her business. The following are some selected transactions for
the first month of its operations. She started her operations on January-1 of the current year. Learn how each
business transactions affect the basic accounting equation.
January 2. Misses Helen deposited Br. 200,000.00 cash in the bank account opened by the name
of Hewan Beauty Salon.
January 3. Hewan beauty salon rented office floor paying Br. 10,000.00 cash.
January 4. The beauty salon purchased beauty equipments paying Br. 150,000.00 cash
January 7. The beauty salon purchased beauty supplies for Br. 25000.00 on credit.
January 25. The beauty salon collected cash of Br. 45000.00 from beauty services
January 26. The beauty salon paid cash of Br. 15000.00 to creditors on account.
January 28. The beauty salon provided beauty services to customers on account for Br. 12000.00
January 29. The beauty salon paid cash of Br. 3000.00 for utilities
January 30. The beauty salon paid cash of Br. 12000.00 for salaries
January 30. Misses Hewan the owner has withdrawn cash of Br 25,000.00 for personal usuage.
Instructions: Analyze the effect of each of the above transactions on the basic accounting equation using a
tabulation format.
January 2. Misses Helen deposited Br. 200,000.00 cash in the bank account opened by the name
of Hewan Beauty Salon.
Transaction( 1 ) Initial investment by the owner
Date Assets = Liability + owners equity Effect of transaction on basic
2024 Cash Hewan capital equation
Jan 2 +200,000 +200,000 Increases assets and equity

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January 3. Hewan beauty salon rented office floor paying Br. 10,000.00 cash
Transaction( 2 ) payment of cash for expenses
Date Assets = Liability + owners equity Effect of transaction on basic
2024 Cash Hewan capital equation
Jan 2 +200,000 +200,000 Increases assets and equity
3 -10,000 -10,000 Decreases both assets and equity
Balance 190,000 = 190,000
January 4. The beauty salon purchased beauty equipments paying Br. 150,000.00 cash
Transaction( 3 ) purchase of equipment for cash
Date Assets = Liability + owners equity Effect of transaction on basic
2024 Cash equipment Hewan capital equation
Jan 2 +200,000 +200,000 Increases assets and equity
3 -10,000 -10,000 Decreases both assets and equity
4 -150,000 +150,000 - - Decreases one asset (cash)
increases another asset ( Equip.)
Balance 190,000 = 190,000
January 7. The beauty salon purchased beauty supplies for Br. 25,000.00 on credit.
Transaction( 4 ) purchase of supplies on account
Date Assets = Liability + owners equity Effect of transaction on basic
2024 Cash Equip supplies Hewan capital equation
Jan 2 +200,000 --- --- +200,000 Increases assets and equity
3 -10,000 --- --- -10,000 Decreases both assets and
equity
4 -150,000 +150,000 - - Decreases one asset (cash)
increases another asset (
Equip.)
7 25,000 25, 000 --- Increases both assets
(supplies) and liabilities( A/P)

Balance 215,000 = 215,000

January 25. The beauty salon collected cash of Br. 45000.00 from beauty services
Transaction( 5 ) Rendering of services for cash
Date Assets = Liability + owners equity Effect of transaction on basic
2024 Cash Equip supplies Hewan capital equation
Jan 2 +200,000 --- --- +200,000 Increases assets and equity
3 -10,000 --- --- -10,000 Decreases both assets and equity
4 -150,000 +150,000 - - Decreases one asset (cash)
increases another asset ( Equip.)

7 25,000 25, 000 --- Increases both assets (supplies) and

liabilities( A/P)

25 +45,000 +45,000 Increases both assets (cash) and

equity (Revenue)

Balance 260,000 = 260,000

Berhan K: 2024 Page 14

January 26. The beauty salon paid cash of Br. 15000.00 to creditors on account.
Transaction( 6 ) partial settlement of amount owed
Date Assets = Liability + owners equity Effect of transaction on basic
2024 Cash Equip supplies Hewan capital equation
Jan 2 +200,000 --- --- +200,000 Increases assets and equity
3 -10,000 --- --- -10,000 Decreases both assets and
equity
4 -150,000 +150,000 - - Decreases one asset (cash)
increases another asset (
Equip.)
7 25,000 25, 000 --- Increases both assets
(supplies) and liabilities(
A/P)
25 +45,000 +45,000 Increases both assets (cash)
and equity (Revenue)

26 -15,000 -15000 Decreases both assets (cash)

and liabilities ( A/P )

Balance 245,000 = 245,000

January 28. The beauty salon provided beauty services to customers on account for Br. 12000.00
Transaction( 7 ) Rendering of services on account
Date Assets = Liability + owners Effect of transaction on
2024 equity basic equation
Cash Equip supplies A/R Hewan
capital
Jan 2 +200,000 --- --- +200,000 Increases assets and equity
3 -10,000 --- --- -10,000 Decreases both assets and
equity
4 -150,000 +150,000 - - Decreases one asset (cash)
increases another asset (
Equip.)
7 25,000 25, 000 --- Increases both assets
(supplies) and liabilities(
A/P)
25 +45,000 +45,000 Increases both assets (cash)
and equity (Revenue)

26 -15,000 -15000 Decreases both assets

(cash) and liabilities ( A/P )

28 +12,000 +12000 Increases both assets (A/R)

and equity (Revenue)

Balance 257,000 = 257,000

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January 29. The beauty salon paid cash of Br. 3000.00 for utilities
Transaction( 8 ) Payment of cash for utilities expenses
Date Assets = Liability + owners Effect of transaction on basic
2024 equity equation
Cash Equip supplies A/R Hewan
capital
Jan 2 +200,000 --- --- +200,000 Increases assets and equity
3 -10,000 --- --- -10,000 Decreases both assets and
equity
4 -150,000 +150,000 - - Decreases one asset (cash)
increases another asset (
Equip.)
7 25,000 25, 000 --- Increases both assets
(supplies) and liabilities( A/P)

25 +45,000 +45,000 Increases both assets (cash)

and equity (Revenue)

26 -15,000 -15000 Decreases both assets (cash)

and liabilities ( A/P )

28 +12,000 +12000 Increases both assets (A/R)

and equity (Revenue)

29 -3000 -3000 Decrease asset (cash) and

equity(payment utility
expenses)
Balance 254,000 = 254,000

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January 30. The beauty salon paid cash of Br. 12000.00 for salaries
Transaction( 9) Payment of cash for salary expenses
Date Assets = Liability + owners Effect of transaction on basic
2024 equity equation
Cash Equip supplies A/R Hewan
capital
Jan 2 +200,000 --- --- +200,000 Increases assets and equity
3 -10,000 --- --- -10,000 Decreases both assets and
equity
4 -150,000 +150,000 - - Decreases one asset (cash)
increases another asset (
Equip.)
7 25,000 25, 000 --- Increases both assets
(supplies) and liabilities( A/P)

25 +45,000 +45,000 Increases both assets (cash)

and equity (Revenue)

26 -15,000 -15000 Decreases both assets (cash)

and liabilities ( A/P )

28 +12,000 +12000 Increases both assets (A/R)

and equity (Revenue)

29 -3000 -3000 Decrease asset (cash) and

equity(payment of expenses)

30 -12000 -12000 Decrease asset (cash) and

equity(payment of salary
expenses )
Balance 242,000 = 242,000

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January 30. Misses Hewan the owner has withdrawn cash of Br 25,000.00 for personal usuage.
Transaction( 10 ) cash withdrawal by the owner
Date Assets = Liability + owners Effect of transaction on basic
2024 equity equation
Cash Equip supplies A/R Hewan
capital
Jan 2 +200,000 --- --- +200,000 Increases assets and equity
3 -10,000 --- --- -10,000 Decreases both assets and
equity
4 -150,000 +150,000 - - Decreases one asset (cash)
increases another asset (
Equip.)
7 25,000 25, 000 --- Increases both assets
(supplies) and liabilities( A/P)

25 +45,000 +45,000 Increases both assets (cash)

and equity (Revenue)

26 -15,000 -15000 Decreases both assets (cash)

and liabilities ( A/P )

28 +12,000 +12000 Increases both assets (A/R)

and equity (Revenue)

29 -3000 -3000 Decrease asset (cash) and

equity(payment of expenses)

30 -12000 -12000 Decrease asset (cash) and

equity(payment of expenses)

30 -25000 -25000 Decrease asset (cash) and

equity(withdrawal by owner)

Balance 217,000 = 217,000

Berhan K: 2024 Page 18

The effect of the above transactions on the basic accounting equation can be summarized as follows:
Date Assets = Liability + owners equity
2024 Cash Equipment supplies A/R A/P Hewan
capital
Jan 2 +200,000 +200,000
3 -10,000 -10,000
4 -150,000 +150,000
7 25,000 25, 000
25 +45,000 +45,000
26 -15,000 -15000
28 +12,000 +12000
29 -3000 -3000
30 -12000 -12000
30 -25000 -25000
31 30,000 150,000 25,000 12000 10,000 207,000
Balance 217,000.00 217,000.00

Berhan K: 2024 Page 19

 2) Financial Statements
After the effect of the individual transactions has been determined, the essential information is communicated to
users at the end of accounting period. The accounting reports, which communicate this information, are called
financial statements. Financial statements are the output of the accounting system. Financial statements are
said to be the central features of accounting because they are the primary means of communicating important
accounting information to users. Financial statements are the means of transferring the concise picture of the
profitability and financial position of the business to interested parties. The major financial statements used to
communicate accounting information about a business are: income statement, balance sheet, statement of
owner’s Equity, and statement of cash flows.
1. Income Statement: An income statement, also known as a profit and loss statement, is a financial report
that summarizes a company's revenues, expenses, and net income or net loss over a specific period of
time.
 It shows the financial progress of the business, over a period of time.
 It provides insights into a company's ability to generate profits from its core business activities and
helps stakeholders assess its profitability and operational efficiency.
 If the revenue of a period exceeds the expenses of that same period, results in net income and if
expenses are greater than the revenues of a period, it results in a net loss.
Hewan Beauty Salon
Income statement
For the month ended January 31, 2024
Revenue
Sales Revenue 57,000.00
Expense
Rent expense 10,000.00
Salary and wages expenses 12,000.00
Utility expense 3,000.00
Total expense (25,000.00)
Net income 32,000.00
2. Statement of owner’s equity: This is a statement summarizes the changes in owner’s equity over a
specific period of time.
 It summarizes the changes over the owners’ equity account.
 It reports on the beginning capital, additional investments/withdrawals by the owner, and the effect
of net income or net loss during the accounting period.

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 Hewan Beauty Salon
statement of owner’s equity
For the month ended January 31, 2024
Hewan capital, January 1, 2024 0
Add: investment by owner 200,000.00
Net income 32,000.00 232,000.00
232,000.00
Less: withdrawal by owner 25,000.00
Hewan’s capital, meskrem 30, 2005 207,000.00
3. Balance Sheet: A balance sheet is a financial statement that presents a company's financial position at a
specific point in time, typically the end of the accounting period( quarter or year). It lists a company's
assets, liabilities, and shareholders' equity.
 It lists the compositions of the assets, liabilities ad owners’ equity on a specific point in time
 It shows the financial position of the business
 It indicates a company's financial health, showing what it owns (assets), what it owes (liabilities),
and the amount of shareholders' equity. It helps stakeholders assess the company's solvency and
liquidity.
HewanBeauty Salon
Balance sheet
January 31,2024
Assets Liabilities
Cash 30,000.00 Accounts payable 10,000.00
A/receivable 12,000.00
Supplies 25,000.00
Equipment 150,000.00 Total liability 10,000.00
Owner’s equity
Hewan’s capital 207,000.00
Total asset 217,000.00 Total liability &owner’s equity 217,000.00
4. Statement of cash flows: The cash flow statement tracks the flow of cash in and out of a company over
a specified period.
 It shows a summary of cash receipts and cash payments during the accounting period.

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